energy etfs and etcs final

8/14/2019 Energy ETFs and ETCs Final

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Energy ETFs and

ETCs

2009 Dimple Singh (20081014)Nidhi Chhajed (20081033)

Puneet Dutt (20081037)

Riddhi Kedia (20081043)

9/14/2009


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Contents

Table of Contents

1. What are ETFs 3

2. What are Energy ETFs?3

3. Green ETFs4

4. Advantages of ETF 9

5. Stapled Securities 20

6. Structured Products 28

What Are ETFs?

In the simplest terms, Exchange Traded Funds (ETFs) are funds that track

indexes like the NASDAQ-100 Index, S&P 500, Dow Jones, etc. When you buy


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shares of an ETF, you are buying shares of a portfolio that tracks the yield

and return of its native index. The main difference between ETFs and other

types of index funds is that ETFs don't try to outperform their corresponding

index, but simply replicate its performance. They don't try to beat the

market; they try to be the market.

ETFs have been around since the early 1980s, but they've come into their

own within the past 10 years.

What are Energy ETFs?

A broad class of ETFs that includes funds focused on oil and gas exploration,

the generation, distribution and retail sale of gas and other refined products,electric utilities and alternative energy production. Energy ETFs may invest

in only US based companies, globally based energy companies, or a blend of

the two.

The offerings within the energy ETF class include replications of the energy-

sector stocks found in the S&P 500, U.S. energy producers, global energy

producers and funds of a particular sub-sector designation, such as nuclear,

coal, gas, etc.

The weighting of stocks within these ETFs can be market-cap based, equally-

weighted or fundamentally weighted, based on financial metrics like net

earnings and dividend yield.

Energy ETFs represent a sector that is widely held by both conservative and

risky investors, because energy represents a large portion of the broad

economy. This is evidenced by energys high percentage allocation within

broad market averages like the S&P 500.

There is also increasing interest in green energy and alternative energy

development, so a growing number of ETFs focus on companies engaged in

alternative and clean energy production.


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Energy ETFs have the advantage of intraday pricing and trading, which can

make them more attractive than similarly invested mutual funds. Investors

should read the fact sheets and prospectuses carefully to be sure of what

guidelines the ETF has with regards to similar focus areas, such as mining

and commodities.

Green ETFs

Green ETFs are ETFs that invest in companies which are looking to benefit

from investing in green technologies and make their money out of clean

energy and related areas.

Here is a list of green energy ETFs.

Power shares Green ETF

Power Shares Wilder Hill Clean Energy Portfolio (PBW): This green ETF tracks

the Wilder Hill Clean Energy Index and will normally invest 80% of its assets

in companies that are engaged in cleaner energy and conservation. The

underlying index has got 54 publicly traded companies with a market cap in

the range of $126 million and $26 billion.

Power Shares Water Resources Portfolio (PHO): This green ETF tracks the

Palisades Water Index and invests in a group of companies that focus on

potable water, water treatment, and the technology and services directly

related to water consumption. The underlying index contains 33 companies

that are publicly traded in US and have market cap in the range of $1.1

billion and $266 billion as on June 30, 2008.

Power Shares Wilder Hill Progressive Energy Portfolio (PUW): PUW green ETF

tracks the Wilder Hill Progressive Energy Index and is comprised of US listed


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companies that are significantly involved in transitional energy bridge

technologies, with an emphasis on improving the use of fossil fuels. This

means that this fund invests in companies that are working towards

improving energy efficiency from fossil fuels and nuclear power in the

medium term. The underlying index comprises of 45 companies with a

market cap between $304 million and $101 billion as on June 30 2008.

Global Nuclear Energy Portfolio (PKN): As the name suggests, PKN is a green

ETF that focuses on companies that are engaged in the nuclear energy

sector. The companies may be present in reactors, utilities, construction,

technology, equipment, service providers and fuels.

Power shares Global Clean Energy Portfolio (PBD): This is a global green ETF,

which means that it invests in companies that are engaged wind, solar,

biofuels, hydro, wave and tidal, geothermal and other relevant renewable

energy businesses around the world. The underlying index contains 86

companies between a market cap of $27.9 million and $18.8 billion as at

December 31st 2008. The companies are domiciled in Australia, Austria,

Belgium, Brazil, Canada, China, Denmark, France, Finland, Germany, Hong

Kong, India, Ireland, Italy, Japan, New Zealand, Norway, Philippines, Spain,

Switzerland, Taiwan, the United Kingdom and the United States.

Power Shares Global Water Portfolio (PIO): This green ETF invests in

companies around the world that focus on the provision of potable water,

the treatment of water and the technology and services that are directly

related to global water consumption.

Power Shares Clean Tech Portfolio (PZD): This is a slightly different type of

green ETF because it invests in Clean Tech companies. Clean Tech

companies are defined as those that provide knowledge-based products (or

services) that add economic value by reducing cost and raising productivity

and/or product performance, while reducing the consumption of resources

and the negative impact on the environment and public health. As of June


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30, 2008 the underlying index consisted of 76 companies with a market cap

between $395.4 million and $101.6 billion.

Power shares Global Wind Energy Portfolio (PWND): PWND is an ETF that

invests in companies that are engaged in the wind energy business globally.

The underlying Index is designed to measure the performance of global

companies engaged in the wind energy industry, which are primarily

manufacturers, developers, distributors, installers and users of energy

derived from wind sources.

Van Eck Green ETF

Global Alternative Energy ETF (GEX): This green ETF invests in global

companies engaged in the production of alternative fuels and / or related

technologies. The Index Country breakdown is quite interesting with US

accounting for 38.3%, followed by Denmark with 19.3%, Spain 15.0%,

Germany 7.2%, China 5.5%, Austria 5.4% and a few other countries with less

than 5%.

Environmental Services ETF (EVX): EVX invests in companies that engage in

business activities that may benefit from the global increase in demand for

consumer waste disposal, removal and storage of industrial by-products, and

the management of associated resources.

Nuclear Energy ETF (NLR): This green ETF focuses on companies that are

related to the nuclear energy business worldwide.

Solar Energy ETF (KWT): The KWT ETF invests in companies that derive at

least 66% of their revenues from solar power and related products and

services.

First Trust Green ETF

First Trust ISE Global Wind Energy Index Fund (FAN): The ETF invests in

companies related to wind energy globally. The maximum country exposure

on this ETF is Spain with 30.35%, followed by Germany with 15.36%,


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followed by US with 10.95%, Denmark 8.22%, Belgium 5.77% and a few

other countries with less than 5%.

First Trust ISE Water Index Fund (FIW): This ETF focuses on companies that

derive a substantial portion of their revenues from potable and wastewater

industries. There are 36 stocks in this index and it has maximum exposure

to the Industrials sector.

First Trust Nasdaq Clean Edge Green Energy Index Fund (QCLN): This

ETF invests in stocks that are publicly traded in the United States and that

are primarily manufacturers, developers, distributors and/or installers of

clean energy technologies.

Claymore Green ETF

Claymore S&P Global Water Index ETF (CGW): This green ETF invests in

water companies globally. It is a passive fund that invests in the stocks of

the underlying index that is composed with 25 securities of water utilities

and infrastructure companies and 25 securities of watery equipment and

material companies.

Claymore / MAC Global Solar Energy Index ETF (TAN): The TAN ETF tracks itsunderlying index which is designed track companies within the following

business segments of the solar energy industry: companies that produce

solar power equipment and products for end-users, companies that produce

fabrication products (such as the equipment used by solar cell and module

producers to manufacture solar power equipment) or services (such as

companies specializing in the solar cell manufacturing or the provision of

consulting services to solar cell and module producers) for solar power

equipment producers, companies that supply raw materials or components

to solar power equipment producers or integrators; companies that derive a

significant portion of their business from solar power system sales,

distribution, installation, integration or financing; and companies that

specialize in selling electricity derived from solar power.


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Benefits

ETFs combine the range of a diversified portfolio with the simplicity of

trading a single stock. Investors can purchase ETF shares on margin, short

sell shares, or hold for the long term.

Passive management Harness the market

The purpose of an ETF is to match a particular market index, leading to a

fund management style known as passive management. Passive

management is the chief distinguishing feature of ETFs, and it brings a

number of advantages for investors in index funds. Essentially, passive

management means the fund manager makes only minor, periodic

adjustments to keep the fund in line with its index. This is quite different

from an actively managed fund, like most mutual funds, where the manager

continually trades assets in an effort to outperform the market. Because

they are tied to a particular index, ETFs tend to cover a discrete number of

stocks, as opposed to a mutual fund whose scope of investment is subject to

continual change. For these reasons, ETFs mitigate the element of

"managerial risk" that can make choosing the right fund difficult. Rather

than investing in a fund manager, when you buy shares of an ETF you're

harnessing the power of the market itself.

Cost-efficient and tax-efficient

ETF tracks an index without trying to outperform it; it incurs fewer

administrative costs than actively managed portfolios. Typical ETF

administrative costs are lower than an actively managed fund, coming in

less than .20% per annum, as opposed to the over 1% yearly cost of some

mutual funds. Because they incur low management and sponsor fees, and

because they don't typically carry high sales loads, there are fewer recurring

costs to diminish your returns.


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Passive management is also an advantage in terms of tax efficiency. ETFs

are less likely than actively managed portfolios to experience the trading of

securities, which can create potentially high capital gains distributions.

Fewer trades into and out of the trust mean fewer taxable distributions, and

a more efficient overall return on investment.

Efficiency is one reason ETFs have become a favored vehicle for multiple

investment strategies - because lower administrative costs and lower capital

gains taxes put a greater share of your investment dollar to work for you in

the market.

Flexibility

ETF shares trade exactly like stocks. Unlike index mutual funds, which are

priced only after market closings, ETFs are priced and traded continuously

throughout the trading day. They can be bought on margin, sold short, or

held for the long-term, exactly like common stock. Yet because their value is

based on an underlying index, ETFs enjoy the additional benefits of broader

diversification than shares in single companies, as well as what many

investors perceive as the greater flexibility that goes with investing in entire

markets, sectors, regions, or asset types. Because they represent baskets of

stocks, ETFs, or at least the ones based on major indexes, typically trade at

much higher volumes than individual stocks. High trading volumes mean

high liquidity, enabling investors to get into and out of investment positions

with minimum risk and expense.

Long-term Growth

It was in the late 1970s that investors and market watchers noticed a trend

involving market indexes - the major indexes were consistently

outperforming actively managed portfolio funds. In essence, according to

these figures, market indexes make better investments than managed

funds, and a buy-and-hold strategy is the best strategy to reap the

advantages of investing in index growth.


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How do indexes work?

A stock market index is a list of related stocks, together with statistics

representing their aggregate value. It is used chiefly as a benchmark for

indicating the value of its component stocks, as well as investment vehicles

such as mutual funds that hold positions in those stocks. Indexes can be

based on various categories of stocks. There are the widely known market

indexes, such as the Dow Jones Industrial Average, the NASDAQ Composite,

or the S&P 500. There are indexes based on market sectors, such as tech,

healthcare, financial; foreign markets; market cap (micro-, small-, mid-,

large-, and mega-cap); asset type (small growth, large growth, etc.); even

commodities.


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Advantages of Exchange-Traded Funds (ETFs)

It was State Street Global Advisors that launched the first exchange-tradedfund (ETF) in 1993 with the introduction of the SPDR. Since then, ETFs have

continued to grow in popularity and gather assets at a rapid pace. The

easiest way to understand ETFs is to think of them as mutual funds that

trade like stocks. Of course, trading like a stock is just one of the many

features that make ETFs so popular, particularly with professional investors

and individual investors who are active traders. Let's go over these

attractive features.

The benefits of trading like a stock

The easiest way to highlight the advantage of the ETF trading like a stock is

to compare it to the trading of a mutual fund. Mutual funds are priced once

per day, at the close of business. Everyone purchasing the fund that day

gets the same price, regardless of the time of day their purchase was made.

Because, like traditional stocks and bonds, ETFs can be traded intraday, they

provide an opportunity for speculative investors to bet on the direction ofshorter-term market movements through the trading of a single security. For

example, if the S&P 500 is experiencing a steep rise in price through the

day, investors can try to take advantage of this rise by purchasing an ETF

that mirrors the index (such as a SPDR), hold it for a few hours while the

price continues to rise and then sell it at a profit before the close of

business. Investors in a mutual fund that mirrors the S&P 500 do not have

this capability - by nature of the way it is traded, a mutual fund does not

allow speculative investors to take advantage of the daily fluctuations of its

basket of securities.

The ETFs stock-like quality allows the active investor to do more than simply

trade intraday. Unlike mutual funds, ETFs can also be used for speculative


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trading strategies, such as short selling and trading on margin. In short, the

ETF allows investors to trade the entire market as though it were one single

stock.


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Low Expense Ratios

Everybody loves to save money, particularly investors who take their

savings and put them to work in their portfolios. In helping investors save

money, ETFs really shine. They offer all of the benefits associated with index

funds - such as low turnover and broad diversification (not to mention the

often-cited statistic that 80% of the more expensive actively managed

mutual funds fail to beat their benchmarks) - plus ETFs cost a lot less.

Compare the Vanguard 500 Index Fund, often cited as one of the lowest of

the low-cost index funds, and the SPDR 500 ETF. The Vanguard fund's

expense ratio of 18 basis points is significantly lower than the 100+ basis

points often charged by actively managed mutual funds. But when

compared to the SPDR's 11-basis-point expense ratio, the Vanguard fund's

expense ratio looks quite high. In fact the SPDR is 40% lower, which is tough

to argue with.

Do keep in mind, however, that because ETFs trade through a brokerage

firm, each trade incurs a commission charge. To avoid letting commission

costs negate the value of the low expense ratio, shop for a low-cost

brokerage (trades under $10 are not uncommon) and invest in increments of

$1,000 or more. ETFs also make sense for a buy-and-hold investor who is in

a position to execute a large, one-time investment and then sit on it.

Diversification

ETFs come in handy when investors want to create a diversified portfolio.

There are hundreds of ETFs available, and they cover every major index

(those issued by Dow Jones, S&P, and NASDAQ) and sector of the equities

market (large caps, small caps, growth, and value). There are international

ETFs, regional ETFs (Europe, Pacific Rim, emerging markets) and country-

specific (Japan, Australia, U.K.) ETFs. Specialized ETFs cover specific


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industries (technology, biotech, and energy) and market niches (REITs,

gold).

And ETFs cover also other asset classes, such as fixed income. While ETFs

offer fewer choices in the fixed-income arena, there are still plenty of

options, including ETFs composed of long-term bonds, mid-term bonds and

short-term bonds. While fixed-income ETFs are often selected for the income

produced by their dividends, some equity ETFs also pay dividends. These

payments can be deposited into a brokerage account or reinvested. If you

invest in a dividend-paying ETF, be sure to check the fees prior to

reinvesting the dividends, as some firms offer free dividend reinvestment,

while others do not.

Studies have shown that asset allocation is a primary factor responsible for

investment returns, and ETFs are a convenient way for investors to build a

portfolio that meets specific asset allocation needs. For example, an investor

seeking an allocation of 80% stocks and 20% bonds can easily create that

portfolio with ETFs. That investor can even further diversify by dividing the

stock portion into large-cap growth and small-cap value stocks, and the

bond portion into mid-term and short-term bonds. Or, it would be just as

easy to create an 80/20 bond-to-stock portfolio that includes ETFs tracking

long-term bonds and those tracking REITs. The large number of available

ETFs enables investors to quickly and easily build a diversified portfolio that

meets any asset allocation model.

Tax Efficiency

ETFs are a favorite among tax-aware investors because the portfolios that

ETFs represent are even more tax efficient than index funds. In addition to

offering low turnover - a benefit associated with indexing - the unique

structure of ETFs enables investors trading large volumes (generally

institutional investors) to receive in-kind redemptions. This means that an

investor trading large volumes of ETFs can redeem them for the shares of


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stocks that the ETFs track. This arrangement minimizes tax implications for

the investor exchanging the ETFs since the investor can defer most taxes

until the investment is sold. Furthermore, you can choose ETFs that don't

have large capital gains distributions or pay dividends (because of the

particular kinds of stocks they track).


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Conclusion

The reasons for the popularity of ETFs are easy to understand. The

associated costs are low, and the portfolios are flexible and tax efficient. The

push for expanding the universe of exchange-traded funds comes, for the

most part, from professional investors and active traders. Nevertheless,

long-term investors will find that the broad-market based ETFs can find a

place in their portfolios when they have an opportunity for occasional large-

size purchases of securities. Investors interested in passive fund

management, and who are making relatively small investments on a regular

basis, are best advised to stick with the conventional index mutual fund. The

brokerage commissions associated with ETF transactions will make it too

expensive for those people in the accumulation phase of the investment

process.

ETF Product Structures

Exchange-traded funds (ETFs) and related exchange-traded products (ETPs)

can use various types of product structures. Each structure has its own

unique advantages and disadvantages. Knowing the subtle differences can

help you to make informed investment decisions.

Lets examine five key product architectures.

Open end funds

The vast majority of traditional ETFs follow an open-end structure. This

product design is quite flexible and allows the usage of derivatives, portfolio

sampling and securities lending. Dividends in open-end funds are

immediately reinvested and usually distributed to shareholders either

monthly or quarterly. The open-end structure is used by major ETF families

like the iShares, State Street Global Advisors and Vanguard. Almost all open-

end ETFs will follow either stock or bond indexes. While the open-fund


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structure is generally tax-efficient, its still a good idea to position tax

inefficient asset classes like bonds or REITs into tax-deferred accounts.


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Unit Investment Trusts (UIT)

The UIT structure is considerably more restrictive compared to the open end

fund. For example, it does not reinvest dividends, but instead holds them

until they're paid out to shareholders. This creates a phenomenon known as

"dividend drag." UITs are not allowed to loan securities in their portfolios and

they must fully replicate their underlying indexes. Also, unlike open-end

funds, UITs have expiration periods which typically last anywhere from a few

years to decades. The Dow DIAMONDS (DIA), Power Shares QQQ Trust

(QQQQ), and the SPDRs S&P500 (SPY) each use the UIT structure. UITs are

generally very tax efficient.

Grantor Trust

This type of product structure is used by popular single commodity ETPs like

the SPDR Gold Shares (GLD) and the iShares Silver Trust (SLV). Since these

products own the physical metal and not the futures contracts on the metal,

gains are taxed at ordinary income rates, which are currently 28%. The

grantor structure is also used by other commodity focused products like the

Power Shares DB Commodity Index Tracking Fund (DBC). Like many other

commodity ETPs, DBC uses futures contracts to obtain its commodities

exposure. ETPs that use futures contracts are taxed each year even if you

don't sell them. Capital gains are currently taxed at a hybrid rate of 60%

long-term and 40% short-term gains. While its rare, some ETPs that invest

in stocks like the HOLDRS use the grantor trust format. All of the HOLDRS

are concentrated baskets of stocks that follow no index. The original stocks

installed inside the trust remain fixed and aren't rebalanced.

Limited Partnerships

The LP structure is used by the United States Oil Fund (USO). Just like the

previously mentioned DBC, this particular LP uses futures contracts to obtain

its oil commodities exposure. LPs that use futures contracts are taxed each


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year even if you don't sell them. Capital gains are taxed at a hybrid rate of

60% long-term and 40% short-term gains. At the end of each tax year,

investors are sent a Schedule K-1.

Exchange Traded Notes

ETNs are debt instruments linked to the performance of a single commodity,

currency or index. They have a set maturity date and they do not usually

pay an annual coupon or specified dividend rate. ETNs can be traded or

redeemed before the maturity date. If the note is held to maturity, the

investor is paid the return of the notes underlying index, minus the annual

expense ratio. ETNs carry issuer risk which is tied to the credit worthiness of

the financial institution backing the ETN. If the issuers financial condition

deteriorates, it could negatively impact the value of the ETN, regardless of

how its underlying index performs.

Gains on stock, bond and commodity ETNs are taxed at either long-term or

short-term capital gains rates depending on how long you've held them.

Typically these types of ETNs don't distribute dividends or interest income,

so they are very tax-efficient. In 2007, the IRS ruled that currency ETNs

should be taxed as bonds, regardless of whether the interest inside the note

is automatically reinvested and not paid out until the note holder sells their

ETN.

ETFs Provide Easy Access to Energy Commodities

If you fill up a car with gasoline or heat a home with oil or natural gas, you

know that rising energy costs have put a dent in your budget. But do you

also know how easy it is to buy shares in a brokerage account or IRA that

can help you hedge energy commodity price increases?

This article will help investors understand the benefits of investing in energy

commodity ETFs and detail choices available to interested investors. It

specifically covers investments that seek to track commodities prices - not


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ETFs that invest in energy sector stocks, in which investment returns are

influenced by the overall direction of the stock market and do not always

mirror energy commodities prices.


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World of ETFs

In recent years, thanks to the growth of exchange-traded funds (ETFs),

ownership of energy-sector commodities has become more accessible for

individuals. For example, buying one share of the U.S. Oil Fund ETF

(AMEX:USO) gives you exposure roughly equal to one barrel of oil. If oil

prices rise by 10% in a given period, your investment should theoretically

appreciate by about the same percentage. You can own oil through this ETF

without incurring the cost normally associated with storage or transport. The

only costs that you will pay include brokerage fees to buy and sell shares

plus a modest ongoing management fee.

USO is not mentioned as a specific investment recommendation. It is

significant because it was the first energy commodity ETF introduced, in

February of 2006, and remains one of the most popular by asset size and

trading volume. Since USO's introduction, ETF energy commodity choices

have greatly expanded.

Why invest in energy commodity ETFs?

ETFs are traded on exchanges (like stocks), and shares may be bought or

sold throughout the trading day in large or small amounts.

At the heart of the "energy complex" is crude oil and products refined from

it, such as gasoline and home heating oil. Natural gas is a by-product of oil

exploration and a valuable product in its own right, used throughout the

world for heat and power generation. Lesser products in the energy complex

include coal, kerosene, diesel fuel, and propane and emission credits.

Energy commodity ETFs can be useful tools for constructing diversified

investment portfolios for the following reasons:

1. Inflation hedge and currency hedge potential - Energy has

recognized value all over the world, and this value does not depend on any


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nation's economy or currency. Over time, most energy commodities have

held their values against inflation very well. For example, the spot price of a

barrel of crude oil increased at an average annual rate of 6.5% per year from

1950 through 2007. Over the same span, the annualized increase in the U.S.

Consumer Price Index was 3.9%. Energy prices tend to move in the opposite

direction of the U.S. dollar - prices increase when the dollar is weak. This

makes energy ETFs a sound strategy for hedging against any dollar declines.

2. Participation in global growth - Demand for energy commodities keep

growing in industrializing emerging markets such as China and India. In

2007, as in most years, the U.S. consumed about 25% of the world's 85

million barrels of total daily oil production, and U.S. consumption has been

increasing by about 3% per year, according to the International Energy

Agency. Some experts believe that it will be difficult for global oil production

to grow in the future due to dwindling reserves, especially in Saudi Arabia. In

addition, several of the world's leading oil export nations (ex. Russia, Iran,

Iraq, Venezuela and Nigeria) are politically volatile and could be unreliable

as future sources of supply.

3. Portfolio diversification - According to modern portfolio theory,

investors can increase portfolio risk-adjusted returns by combining low-

correlating assets in which returns do not tend to move in the same

direction at the same time. However, few asset classes accessible to

individual investors have consistently produced low correlations with U.S.

stocks. Correlations are measured on a scale of 1 (perfect correlation) to -1

(perfectly negative correlation). Oil is among the few asset classes that have

consistently produced very low (or negative) correlations with U.S. stocks.According to Fact Set, the correlation between oil futures and the S&P 500

Index was -0.31 for the five-year period 2002-2007. For this reason,

investors can expect oil commodity holdings to help diversify and balance

stock-heavy portfolios.


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4. Backwardation - Backwardation is the most complex (and least

understood) benefit of some energy commodity ETFs. These ETFs place most

of their assets in interest-bearing debt instruments (such as short-term U.S.

Treasuries), which are used as collateral for buying futures contracts. In

most cases, the ETFs hold futures contracts with the least time left to

delivery - so-called "short-dated" contracts. As these contracts approach the

delivery date, the ETFs "roll" into the next shortest-dated contracts.

Most futures contracts typically trade in contango, which means that prices

on long-delivery contracts exceed short-term delivery or spot prices.

However, oil and gasoline historically have often done the opposite, which is

called backwardation. When an ETF systematically rolls backwardated

contracts, it can add small increments of return called "roll yield", because it

is rolling into less expensive contracts. Over time, these small increments

add up significantly, especially if backwardation continues.

Although this explanation may sounds highly technical, roll yield historically

has been the dominant source of investment return in oil, heating oil and

gasoline futures contracts. According to an analysis by author and analyst

Hilary Till, long-term annualized returns of these futures contracts exceeded

spot prices significantly, as shown in Figure 1, below, and the major reason

for this differential was backwardation roll yield.

Annualized Returns from 1983 to 2004

-Futures

Contract

Spot

Price

Crude Oil 15.8% 1.1%

Heating Oil 11.1% 1.1%


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Gasoline (since Jan.

1985)18.6% 3.3%

Source: "Structural Sources of Return and

Risk in Commodity Futures Investments"

by Hilary Till(Commodities Now, June 2006)

Figure 1

It should be noted that these energy contracts occasionally move from

backwardation to contango for intervals of time. During such times, roll yield

may be lower than shown in the table; they may even be negative.

Historically, natural gas has not shown the same tendency toward

backwardation and roll yield benefit as the three contracts listed in the

table.

Types of Energy ETFs

Energy ETFs can be divided into three main groups:

1. Single contract - These ETFs participate principally in single futures

contracts. For example, the iPATH S&P GSCI Crude Oil Total Return Index

(NYSE:OIL) exchange-traded note (ETN) participates in the West Texas

intermediate (WTI) light sweet crude oil futures traded on the New York

Mercantile Exchange. Note: An ETN is an exchange-traded note, a structure

that works much the same way as an ETF. Power Shares DB Oil Fund

(AMEX:DBO) participates in the same WTI contract.

USO, the pioneering energy commodity ETF, is a subject of some

controversy because it nominally participates in a single contract (WTI),


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while also dabbling in several other energy complex contracts. Therefore,

most investors do not consider it be a pure single-contract ETF.

2. Multi-Contract - These ETFs offer diversified exposure to the energy

sector by participating in several futures contracts. The iShares S&P GSCI

Commodity-Indexed Trust (NYSE:GSG) has about two-thirds of its total

weight in the energy sector and the remaining one-third in other types of

commodities. It tracks one of the oldest diversified commodities indexes, the

S&P GSCI Total Return Index.

Power Shares DB Energy Fund (AMEX:DBE) is a pure energy sector fund

diversified across commodity types. It participates in futures contracts for

light sweet crude oil, heating oil, Brent crude, gasoline and natural gas. The

ETF seeks to track an index that optimizes roll yield by selecting futures

contracts according to a proprietary formula.

3. Bearish - Energy sector commodities can be volatile, and some investors

may want to bet against them at times. The first "bearish" energy

commodity ETF is Claymore MACRO shares Oil down Trade able Trust

(AMEX:DCR). It is designed to produce the inverse of the performance of WTI

oil. This ETF is one-half of a pair of MACRO shares, a concept through which

two ETFs are issued together but traded separately to track, respectively,

the up and down movements in a commodity. (The other half of this pair is

Claymore MACRO shares Up Trade able Trust (AMEX: UCR).

Final Points

While ETFs have made energy sector commodities more accessible to

investors, it's important for investors to understand the mechanics of how

individual ETFs work. Specifically, investors should realize that virtually all of

these ETFs participate in futures contracts, and the "roll yield" of these

contracts can be a major source of positive or negative return, depending on

patterns of backwardation or contango. Multi-contract ETFs such as GSG and

DBE can be a good way to add broad energy exposure across multiple


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contracts. But at times, some of these contracts may be in backwardation

(producing positive roll yield) while others are in contango (producing

negative roll yield).

For investors who own stock-heavy portfolios denominated in U.S. dollars

and wish to increase diversification and inflation-hedge potential, some

energy sector exposure may be advisable. However, it's a good idea to have

a long-term horizon for such investments because they can be volatile over

brief periods. Crude oil can be an especially valuable commodity for adding

diversification because it has consistently produced negative correlations

with U.S. stocks.


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What are stapled securities?

Stapled securities are created when two or more different things are

contractually bound together so that they cannot be sold separately. Many

different types of securities can be stapled together. For example, many

property trusts have their units stapled to the shares of companies with

which they are closely associated. The effect of stapling will depend upon

the specific terms of the stapling arrangement. The issuer of the stapled

security will be able to provide you with detailed information on their

particular stapling arrangement. However, in general the effect of stapling is

that each individual security retains its legal character and there is no

variation to the rights or obligations attaching to the individual securities.

Although the stapled security must be dealt with as a whole, the individual

securities that are stapled are treated separately for tax purposes. For

example, if a share in a company and a unit in a unit trust are stapled: the

owner continues to include dividends from the company and trust

distributions from the trust separately in their income tax return, and the

share is a separate capital gains tax (CGT) asset from the unit so capital

gains and losses are determined separately for each asset. Because each

asset that makes up your stapled security is a separate CGT asset, you must

work out a cost base and reduced cost base for each of them. If you

acquired the assets after they were stapled you do this by apportioning, on a

reasonable basis, the amount you paid to acquire the stapled security (and

other costs) between the various assets.

In real estate a common model internalizes management - where an ASX

listed trust and its own management company trade together. It may link a

passive (rental) income with a more active (non-rental) one. Income in the


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active business may be fee-based (relatively stable) or profit based (e.g. a

development company).


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Gives a company greater earnings stability

Provides a greater scale

Provides diversification or vertical integration

Provides product flexibility

Management interests aligned and fees retained in group

...And the securities all have quite different characteristics!

Basis of apportionment

One reasonable basis of apportionment is to have regard to the portion of

the value of the stapled security that each asset represented. The issuer of

the stapled security may provide assistance in determining these amounts.

Example

On 1 September 2002 Cathy acquired 100 ABC stapled securities which

comprised a share in ABC Ltd and a unit in the ABC Unit Trust. She paid

$4.00 for each stapled security and, on the basis of the information provided

to her by the issuer of the stapled securities, she determined that 60% of

the amount paid was attributable to the value of the share and 40% to the

value of the unit. On this basis, the first element of the cost base and

reduced cost base of each of Cathy's shares in ABC Ltd will be $2.40

($4.00 x 60%). The first element of the cost base and reduced cost base of

each of Cathy's units in ABC Unit Trust will be $1.60 ($4.00 x 40%)

If you acquired your stapled securities as part of a corporate reorganization,

such as the 2004 arrangement undertaken by the Westfield Group, you will,

during the restructure, have owned individual assets that were not stapled.

The cost base and reduced cost base of each of these assets will be

calculated in accordance with the specific terms of the stapling

arrangement. The stapling does not result in any CGT consequences for you,

because the individual assets are always treated as separate assets.


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However, as the example below demonstrates, there may be other aspects

of the whole restructure arrangement that will result in CGT consequences

for you.


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Example

Jamie acquired 100 units in the Westfield America Trust (WFA) in January

2003. Immediately prior to the merger of WFA with Westfield Holdings Ltd

(WSF) and Westfield Trust (WFT) in July 2004, the cost base of each of his

units was $2.12 (total cost base = $212 ($2.12 x 100)).

Under the arrangement Jamie's original units in WFA were firstly

consolidated in the ratio of 0.15 consolidated WFA units for each original

WFA unit. After the consolidation, Jamie held 15 consolidated WFA units with

a cost base of $14.13 ($212/15) each. There are no CGT consequences for

Jamie as a result of the consolidation of his units in WFA. Jamie then

received a capital distribution of $1.01 for each consolidated unit he held.

CGT event E4 happens as a result of the capital distribution. Consequently,

Jamie must reduce the cost base of each of his consolidated WFA units by

$1.01 to $13.12.

The capital distribution was compulsorily applied to acquire a share in WSFand a unit in WFT. The cost base and reduced cost base of Jamie's new units

in WFT will be $1.00 and $0.01 for each new WSF share.

The securities were then stapled to form a Westfield Group security. There

are no CGT consequences for Jamie as a result of the stapling of each

consolidated WFA unit to each new WFT unit and WSF share.


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Following the arrangement, Jamie holds 15 Westfield Group Securities each

with a total cost base of $14.13. Each security is made up as follows:

Element Cost base (initial)

WFA unit $13.12

WFT unit $1.00

WSF share $0.01

Total $14.13

You must apportion the capital proceeds you received for the stapled

security between the various assets in the stapled security and then work

out whether you have made a capital gain or loss from each asset. If you

acquired a particular asset on or after 20 September 1985, you will make a

capital gain on the disposal of that asset if the capital proceeds received

from the disposal exceed your cost base. You will make a capital loss if your

reduced cost base is greater than your capital proceeds.

Note: Some securities may have additional taxation provisions that applyupon disposal for example, traditional securities also attract the traditional

security provisions.

Any capital gain or capital loss made on the disposal of a security in a

stapled security acquired before 20 September 1985 will be disregarded.

Example

On 1 August 1983 Kelley purchased 100 shares in XYZ Ltd for $4.00 per

share. In August 2002, Kelley was allocated 100 units in XYZ Unit Trust

under a corporate reorganization of the XYZ Group. The units were acquired

for $1.00 each, with the funds to acquire the units coming from a capital

reduction made to her shares. At that same time, Kelley's shares in XYZ Ltd


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and units in XYZ Unit Trust were stapled and became known as XYZ stapled

securities.

Kelley disposed of all of her XYZ stapled securities on 1 March 2004 for

$8.00 per security. On the basis of the information provided by the issuer of

the stapled securities, Kelley determined that of this amount 70% or $5.60

per share ($8.00 x 70%) was attributable to the value of her XYZ Ltd shares

and 30% or $2.40 per unit ($8.00 x 30%) to the value of her units in the XYZ

Unit Trust.

Kelley must account for the sale of each of the elements (shares and units)

of the stapled securities separately. As Kelley acquired her XYZ Ltd shares

before 20 September 1985, any capital gain or capital loss she makes on

the disposal of these shares will be disregarded.

Kelley will make a capital gain of $1.40 per unit ($2.40 $1.00) on the

disposal of her units in the XYZ Unit Trust. As Kelley owned those units for

more than 12 months, she may choose to apply the CGT discount to further

You must apportion the capital proceeds you received for the stapled

security between the various assets in the stapled security and then work

out whether you have made a capital gain or loss from each asset. If you

acquired a particular asset on or after 20 September 1985, you will make a

capital gain on the disposal of that asset if the capital proceeds received

from the disposal exceed your cost base. You will make a capital loss if your

reduced cost base is greater than your capital proceeds.

Note: Some securities may have additional taxation provisions that apply

upon disposal for example, traditional securities also attract the traditional

security provisions.


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Any capital gain or capital loss made on the disposal of a security in a

stapled security acquired before 20 September 1985 will be disregarded.

Example

On 1 August 1983 Kelley purchased 100 shares in XYZ Ltd for $4.00 per

share. In August 2002, Kelley was allocated 100 units in XYZ Unit Trust

under a corporate reorganization of the XYZ Group. The units were acquired

for $1.00 each, with the funds to acquire the units coming from a capital

reduction made to her shares. At that same time, Kelley's shares in XYZ Ltd

and units in XYZ Unit Trust were stapled and became known as XYZ stapled

securities.

Kelley disposed of all of her XYZ stapled securities on 1 March 2004 for

$8.00 per security. On the basis of the information provided by the issuer of

the stapled securities, Kelley determined that of this amount 70% or $5.60

per share ($8.00 x 70%) was attributable to the value of her XYZ Ltd shares

and 30% or $2.40 per unit ($8.00 x 30%) to the value of her units in the XYZ

Unit Trust.

Kelley must account for the sale of each of the elements (shares

and units) of the stapled securities separately.

As Kelley acquired her XYZ Ltd shares before 20 September 1985, any

capital gain or capital loss she makes on the disposal of these shares will be

disregarded.

Kelley will make a capital gain of $1.40 per unit ($2.40 $1.00) on the

disposal of her units in the XYZ Unit Trust. As Kelley owned those units formore than 12 months, she may choose to apply the CGT discount to further

reduce her capital gain.

Scrip for scrip roll-over relief enables a shareholder to disregard a capital

gain they make from a share that is disposed of as part of a corporate


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Expiry date: Undated

Underlying assets: FTSE 100 (current index level 5000)

Conversion ratio: 1000:1 (1000 trackers per index unit)

Strike: 0

Exercise style: European

Tracker priced at: 500p

Figure 1: (Source: London exchange.com)

As can be seen from Fig 1, the tracker replicates the index without

leverage. In this case, should the FTSE 100 fall 500 points, the tracker will

lose 50p in value and should the FTSE 100 rise 500 points, the tracker will

gain 50p in value.

Although no dividend is paid out, any income streams are built into the

capital value of the tracker over its lifetime. However, as always, the precise

terms should be checked with the Issuer.

Below is a further example this time the underlying is the S&P 500 index.

Trackers are not limited to equity indices, and in fact can be issued on any

underlying asset; however this is a useful example because of the currency

risk.


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Bonus Tracker:

These instruments have slightly more complex structures comparable to

fixed-term life products or insurance bonds.

However, they are continuously priced throughout their lifetime and

investors do not face early redemption penalties. In addition, bonus trackers

can be issued as much shorter-dated instruments where required.

A bonus tracker is a combination product incorporating:

a zero strike Call (or standard tracker)

a barrier option (down-and-out Put)

The tracker simply replicates the performance of an underlying with no

leverage and will expire at the value of the instrument or index it is tracking.

A down-and-out Put is a type of option called a barrier option which ceases

to exist when the underlying asset reaches a predetermined level (in our

next example, 3000) and is therefore cheaper than a standard option.

Figure 2:

Bonus tracker

Issuer: ABC Bank


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Issue date: January 2005

Expiry date: January 2010

Bonus Level: 6000

Barrier level: 3000

Underlying asset: FTSE 100

Conversion ratio: 1000:1

Issue price: 450p

Above is an example of a FTSE 100 bonus tracker with a bonus level of 6000

(which translates to 600p due to the conversion ratio of 1000:1) and a

barrier level of 3000. This product is the combination of a zero strike Call (or

tracker) and a Put option with a strike of 6000 and a knock out level of 3000.

This means that should the FTSE 100 fall below 3000 at any point during the

five year life of this product, the Put component will knock-out leaving the

product as a simple tracker which will track the FTSE 100 index until expiry.

However, if the FTSE 100 doesnt fall below the barrier level of 3000, the Putoption will remain guaranteeing a minimum payout level of 6000 (i.e. 600p)

at expiry regardless of where the FTSE 100 index is at expiry (above the

barrier level of 3000).

At maturity

On expiry the FTSE 100 index closes at 4000 having never fallen below 3000

during the five year lifespan of the product. The zero strike Call (or tracker)

has a value of 400p while the Put has a value of 200p (strike price final

index level) giving a total return of 600p.

If, on the other hand, the FTSE 100 had fallen below 3000 at any point

during its lifetime, then the Put option would have knocked out and the

total return would simply be that of the zero strike Call (or plain tracker) of


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400p. Should the closing level of the FTSE 100 be above 6000 at expiry (e.g.

7050), the total return would be that of the zero strike Call (or tracker) of

705p. This is the case even if the barrier level has previously been hit.

Accelerated trackers

Accelerated trackers are growth orientated structured products.

These instruments give additional upside performance whilst maintaining a

1:1 relationship on the downside in return for surrendering income streams

related to the underlying asset.

Figure 3:

In the example above, the two dotted lines represent the pay-out profiles of

the plain tracker and at-the-money Call option which form the components.

The solid line represents the profit and loss profile of the accelerated

tracker.

At maturity

On expiry, the holder of the accelerated tracker has the right to:

1. If the final underlying asset price is greater than or equal to the

initial underlying asset price: Initial price + (initial price x [participation level

x change in underlying])

2. Otherwise: Initial price + (initial price x change in underlying)


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This means that should the index have risen 10% in value at maturity, then

the investor will receive a 21% profit. In this case, 121 in cash (100 + (100

x [210% x 10%])).

The investor does not have to worry about the currency risk associated with

the underlying asset being priced in Yen as this product is Quanto and

currency risk is hedged out on the investors behalf by the issuing bank.

Despite the accelerated upside, the investor faces no additional downside

risk (excluding foregoing any income). Should the index have fallen 10% at

maturity, the investor will realize a loss of -10%, in this case 9.

Reverse trackers

Reverse trackers are very similar to standard trackers but have an

inverse relationship with the underlying asset should the price of

the underlying asset fall, the price of the reverse tracker will rise.

These products can also be referred to as bear certificates.

Figure 4:

Figure 4 shows the inverse relationship the reverse tracker has with the

price of Lloyds TSB plc if the share price falls 10p, then the reverse tracker

price would rise 10p and vice versa.

Reverse tracker


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Issuer: ABC Bank

Issue date: February 2005

Expiry date: February 2010

Underlying Asset: Lloyds TSB plc (current Lloyds price 475p)

Conversion ratio: 1:1

Strike: 800p

Exercise style: European

Issue price: 325p

In effect, this is a Put option, but so deeply in-the-money as to have a linear

price relationship with the underlying. However, should the underlying asset

price increase dramatically towards the strike, the linear relationship will

break down and the instrument will increasingly take on the characteristics

of a standard Put option.

As with all trackers, no dividends are paid, but any income streams are built

into the capital value of the tracker over its lifetime check the pricing

supplement for details specific to each product.

Discount trackers

Discount trackers allow investors to buy into the performance of an

asset at a discount to the actual underlying price.

However, the potential gain is limited to a pre-defined level (the

cap level).

A discount tracker is a combination product incorporating:

a zero strike Call (or tracker)


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writing a Call option

The tracker simply replicates the performance of an index as described

above, with no leverage, and will simply expire at the value of the index or

underlying it is tracking.

This is akin to covered call writing where the options writing income

translates to a discount on the underlying asset. Selling the Call option

means that the investor benefits from the premium, hence the discount.

Upside is capped however, as any rise in value of the underlying asset above

the strike price is cancelled out by the liability created in selling the Call

option (Call option strike price = cap level).

Discount tracker

Issuer: ABC Bank

Issue date: February 2005

Expiry date: February 2006

Cap: 430p

Underlying asset: Marks & Spenser (M&S)

Conversion ratio: 1

Underlying price: 400p

Product price: 360p (10% discount)


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Figure 5:

In the example above, the two dotted lines represent the profit and loss

expiry profiles of the tracker and the short Call option. The solid line

represents the profit and loss profile of the discount tracker.

At maturity

Should the value of M&S increase by 25% to 500p, the discount tracker

would reach the cap limit of 430p (a 19.4% rise in value).

Should the value of M&S increase by 7% to 428p, the value of the discount

tracker will be 428p (an 18.9% rise in value).

Should the value of M&S fall by 20% to 320p, the value of the discount

tracker would also fall to 320p (but because of the discount purchase price,

this would represent only an 11.1% fall in value).

It can be seen from the above that additional downside protection is

purchased at the expense of limiting upside exposure above a certain level.

As with all trackers, no income is paid out but, according to the terms of

each product, is built into the capital value.


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Figure 6:

As can be seen from the above chart, the investor faces no downside risk

over the three year lifetime of the product but takes part in 100% of any

upside performance.

This achieved by purchasing a zero coupon bond and using the discount

from nominal value to invest in a call option. The zero coupon bond matures

at par, thereby guaranteeing the investors capital, whilst the call option

maintains the upside exposure required

At maturity

On expiry, the holder of the capital protected instrument has the right to:

1. If the final underlying asset price is greater than or equal to the initial

underlying asset price:

Initial price + (change in underlying / conversion ratio x participation)

2. Otherwise:

The higher of

a) Initial price / conversion ratio x protection level

b) Final price / conversion ratio


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In this case, regardless of whether the index falls to zero by the time the

product expires, the investor is guaranteed to receive the initial price of the

product when launched. So a fall of -100% equates to a 0% movement in

the product.

Should the index rise over four years, then the investor fully partakes in any

capital appreciation. A 15% rise in the FTSE100 will result in a 15%rise in

the value of the product. However, it should be remembered that the income

attributable to the underlying asset has been given up in order to achieve

this payout profile.

energy etfs and etcs final

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