New Security Offers Easy Play on Livestock

As one who's drawn to off-the-radar ideas, I've embraced these innovations with gusto over the years, highlighting fixed-income exchange-traded funds, or ETFs, when they were launched back in 2002 and currency products back in 2005.

Another landmark was reached when Barclays debuted the iPath Dow Jones-AIG Livestock Total Return Sub-Index (COW), an oddball exchange-traded note, or ETN, that gets my vote for product of the year. This tiny security, launched in October and not even at $10 million in market cap, represents a new breakthrough for investors by opening up an asset most of us enjoy but few have ever actually traded.

Livestock refers to the agricultural raising of animals, usually for food or fiber. Within the context of domestic investments, that means cattle and pork. Both have mature markets, which commodity players trade using spot and futures contracts. But if you didn't run a feedlot or weren't comfortable trading cattle futures, then getting long or short exposure to livestock simply wasn't an option.

But the Livestock ETN makes going long your Christmas ham just as easy as buying Dell (DELL). About 70% of the security is held in live cattle and about 30% is in lean hogs. As those commodities rise and fall during the trading day, so does the price of the NYSE-listed note.

Although they are traded in much the same fashion, the main difference between ETNs and the more familiar ETFs is that ETNs are debt obligations in which the sponsor, in this case Barclays, is expected to pay out the underlying assets' return at maturity, less than a 0.75% annual expense ratio.

So although an ETN doesn't actually hold the underlying assets, be it corn or cows, an active arbitrage means one can expect the price performance of ETNs to accurately track their benchmarks. COW matures in 2037. Of course, one need not hold it until maturity, as market makers quote the security all day long and it trades just like a stock.

From a portfolio perspective, livestock adds a unique diversification that few other assets can top. The ETN boasts an insignificant correlation to all major financial asset classes, including a -0.01 relationship to the S&P 500, -0.05 to the Lehman Brothers Aggregate Bond Index and 0.03 to the MSCI EAFE Index of world stocks. Interestingly, even its correlation with other commodities isn't that strong, showing a slightly positive 0.09 relationship to the Dow Jones-AIG Commodity Index, compared with a very strong 0.72 correlation for crude oil. This is truly an asset that moves to its own beat.

I admit to a little bias in evaluating COW. Although I grew up not eating pork, after reaching college it became a welcome part of my diet, from Cobb salads to Cuban sandwiches. With all respect to the vegetarians out there, pork is the irresistible ingredient of the culinary world. Once you've tried it, it's virtually impossible to un-acquire a taste for it.

Prosperity and protein have always gone together. The more affluent a society is, the more meat — especially higher-quality cuts of meat — its citizens tend to consume. That's one of the big reasons global meat consumption is expected to grow 2% every year until 2015.

Impoverished societies, which by the way are almost always non-capitalist, tend to rely on soybeans and legumes for the majority of their protein. As people become more affluent, they are able to afford better meat: from chicken to pork to beef.

Indeed, it's the growing global prosperity that could easily be the catalyst for a major bull move in livestock. Half of the world's pork is now eaten in China, while Brazil is the second-largest consumer of beef after the U.S. As emerging-market economies grow, more disposable income goes toward importing meat. Of course, that world demand can cut both ways. Meat prices collapsed in 1998 in the wake of the Asian financial crisis as demand from the Far East plummeted.

In today's market, there's a bullish fundamental case to be made as well. Rising prices for corn, a key feed ingredient, have led to a reduction of livestock herds and, consequently, higher prices for beef. Since 2000, live cattle prices have moved to 95 cents per pound from roughly 70 cents. Lean hog prices, although more volatile, haven't seen the big upward push as so many other commodities have...yet.

There are dozens of eccentric funds now trading, from the HealthShares Dermatology and Wound Care ETF (HRW) to the Claymore/Robb Report Global Luxury Index (ROB). Most simply aggregate a selection of companies from one sector or industry, slap on a catchy title and list at a nearby exchange.

The Livestock ETN, however, delivers on a simple proposition: liquid and easy access to an asset class previously untradable to most U.S. stock investors. Cattle and pork, long staples of American dinner plates, might increasingly be included in the portfolios of open-minded investors looking to up their game. Anybody hungry?

Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC. At the time of writing, Hoenig's fund held some of the securities mentioned.