Plans are afoot to create exchange-traded funds specializing in diamonds, but advisers are warning that such investments are fraught with challenges and risks.
Diamonds are more difficult to package and price in fund portfolios
than other types of commodities such as gold and silver, portfolio
managers point out.
"Unlike gold, diamonds trade in a very
fractured private marketplace that is highly opaque and ripe with
opportunities for pricing markups," says Greg Peterson, investment
research director at Ballentine Partners in Waltham, Mass., which
manages $4 billion in assets.
While a diamond ETF hasn't arrived in the U.S. yet, Mr. Peterson is
suggesting that investors prepare for a host of new funds. More than
likely, he believes that ETF sponsors are trying to capitalize on the
success of other popular commodity funds, such as the $76.1 billion SPDR
Gold Shares Trust (GLD).
"This is typical of the ETF industry--someone takes an interesting
financially engineered product like GLD and then tries to copy it. But
not everything fits so neatly into an ETF wrapper," Mr. Peterson says.
Several different fund developers are looking to move into the field,
including IndexIQ, known for its ETFs that replicate benchmarks for
hedge funds. It has filed for approval from regulators to create an ETF
that would buy diamonds and physically store them in a vault for
While global pricing information on diamonds is still difficult to
formulate, enough trades are now being done online to make tracking such
moves much more practical, says Abraham Stern, chief executive at
industry researcher IDEX Online in New York.
"We believe enough information is now available to set an objective
statistical base to build transparent pricing structures for an ETF,"
Mr. Stern says, pointing out that IDEX has been benchmarking such
markets since 2004.
Last month, Chicago financial services provider GemShares was granted
a patent for its own benchmarking process that could serve as the basis
for an ETF. A leading driver behind the effort is Andrew Feldman, a
financial adviser inspired by a desire to see diamonds made more
accessible to investors.
"The natural users are industry players, just like airlines are for oil and miners are with gold," Mr. Feldman says.
But just building a diamond ETF doesn't guarantee professional
traders will come, notes Stephen Hammers, chief investment officer at
Compass EMP Funds, a registered investment adviser that runs $1 billion
in separate accounts and mutual funds using ETFs. The firm in Brentwood,
Tenn., includes commodities strategies as one of its areas of
Mr. Hammers views efforts to bring out diamond ETFs more along the
lines of trading in lumber than gold. "Even though it's traded on
exchanges, lumber hasn't attracted enough institutional investors to
gain much in the way of liquidity," he says. "Diamonds could easily run
into the same issues."
Unless a new ETF takes off in a big way, Mr. Hammers warns that
investors might wind up shouldering higher costs related to storage,
insurance and other transactional expenses than they're used to paying
in more popular parts of the commodities marketplace.
Despite such possible structural flaws, a new diamond ETF is likely
to draw at least some initial investor interest, says Andrew Ahrens, an
adviser in Lafayette, La.
His advisory firm, which manages about $900 million in assets, has
been informally asking affluent investors who own diamonds and favor
alternative investments what they think about a diamond ETF.
Almost everyone questioned has found the idea appealing--at least at
first, Mr. Ahrens says. As discussions advanced, however, he found that
most expressed concern about widely perceived discrepancies in the
market related to categorizing and pricing different grades of diamonds.
"Their experiences were so negative, I just don't know how many
people will trust an outside manager at this point to create a fairly
priced and representative basket of diamonds," Mr. Ahrens says.