BOSTON Feb 23 With stocks falling and oil
surging on Mideast turmoil, getting into an ETF based on crude
prices might seem a great way to invest in a few barrels.
But the way new ETFs are trading it's more like getting
half barrels with a lot of suds on top.
It's one of the pitfalls of exchange traded funds that they
often do not do what investors think they will.
While ETFs have added to the wide array of choices for
investors, not all are created equal. And there may be better
ways to benefit from oil's rise by picking other energy-related
The problem for ETFs is matching the funds to the value of
the underlying assets. That is especially difficult when they
are based on commodity futures -- and even more so when there
are sudden market moves, as happened in recent weeks with oil.
ETF managers' efforts to match barrels to fund shares have
proved disappointing in the past. But a new round of ETFs
designed to track oil markets more closely has fallen even
further behind the mark.
Neither of the two "second generation" funds is keeping up
with the latest oil surge. The current month U.S. light crude
futures contract CLc1 on the NYMEX has jumped from its 2011
closing low of $84.32 on February 15 to $99.77 on Wednesday, an
18.3 percent increase.
But the new $550 million PowerShares DB Oil Fund (DBO.P)
has risen only 8.7 percent and the $236 million United States
12 Month Oil Fund (USL.P) is up 7.8 percent.
The two funds were supposed to avoid the lagging
performance of older ETFs like the United States Oil Fund
(USO.P). This time around, the older fund has done best, rising
SIMPLE MATH, DIFFICULT TRADING
The math might seem simple enough. Oil jumped as the Libyan
uprising trimmed about 1 million barrels per day of crude oil
output, estimated Barclays analyst Amrita Sen in a research
Fears of contagion have added still more. Should the unrest
bring production to a halt in neighboring Algeria as well,
Nomura analysts said oil prices could peak at $220 a barrel.
But contagion does not tell the story for why the ETFS lag.
It is the less sinister problem known as contango. That is the
description of a futures markets when prices for later months
rise above those of the present month. And it also creates a
substantial drag on ETFs rolling over contracts on which the
funds are based.
The chance of rising oil prices has put oil futures into a
sharp contango in recent weeks.
Older funds like US Oil invest only in the most current
month of the NYMEX's main oil contract. That means they have to
roll over all their holdings when the contracts expire on a
predictable schedule. And that has allowed other traders to
game the system, pushing up the price of the contracts just as
the funds have to buy.
To avoid this problem, the 12 Month fund splits its
holdings among an entire year's worth of different futures
contracts. The Powershares fund uses its own index that invests
in various months of futures based on a formula that is
supposed to minimize contango problems.
Every fund has its own formula for tracking commodity
prices. Analysts and fund sponsors say investors need to
understand exactly what they are buying.
John Hyland, chief investment officer at US Commodity
Funds, sponsor of the US 12 Month fund, said some investors may
not understand that ETFs cannot exactly match the performance
of the "current month" oil futures contract.
Returns for the "current month" ignore the costs of rolling
over contracts at each month's actual expiration. "It's a
creative fiction," he said.
The Powershares DB fund is designed to capture moves in oil
over longer periods for traditional "buy and hold" investors,
not raid-fire traders, Martin Kremenstein, chief investment
officer for the fund platform, said.
"For a long-term allocation, this is the most efficient way
to stay invested in oil," he said. The fund has gained 26.5
percent since it was introduced in January, 2007, far
outperforming ETFs that stick to the current month's contract
like the original US Oil Fund.
Starting on Wednesday, investors have yet a third option
for oil ETFs. Teucrium Trading, which already manages corn and
natural gas futures funds, is opening the Teucrium WTI Crude
Oil Fund which will trade under the symbol CRUD.
The fund will hold oil futures from three different months
spread over more than a year in an attempt to avoid contango
problems and price squeezes at expiration. But in the short
term it has not kept up with the market's upward move.
OTHER WAYS TO PARTICIPATE
For those who missed the oil price rise entirely, the
smarter investing plays now are probably found elsewhere, say
analysts and fund managers.
Michael Gayed, chief investment strategist at Pension
Partners in New York, favors stocks of alternative energy
producers and the Guggenheim Solar ETF (TAN.P). The fund's top
holdings include First Solar (FSLR.O), Trina Solar TSL.N and
Renewable Energy Corp ASA (REC.OL).
The share prices of oil producers have already run up
dramatically, leaving alternative energy stocks far behind.
"While the energy sector has had a strong move since
November, I'd rather buy something which has more potential to
catch up," he said.
Guggenheim Solar is up only 7.7 percent over the past year
versus a 50.8 percent jump in the iShares Dow Jones US Oil
Equipment ETF (IEZ.P) and a 40.8 percent rise in the broader
Energy Select Sector SPDR ETF (XLE.P).
"As the price of oil rises, alternative energy becomes more
and more correlated and starts to look like a leveraged oil
play," Gayed said. "With this big shock, there will be a huge
amount of new money going into wind turbines, solar and other
The run-up in oil producers may be flashing a warning sign
of a possible short-term setback as the crisis settles down,
according to Justin Walters, co-head of research and
investments at Bespoke Investment Group in Harrison, New York.
The energy sector's recent 40 percent gain has been matched
only five other times since 1940. And four out of the five
times, the move over the next month was down, Walters said.
"We're due for a pullback here," Walters said.
(Reporting by Aaron Pressman. Editing by Richard Satran)