Best commodities - Tips to track the oil price using exchange traded funds (ETFs) : Investors wanting to track the soaring oil price with exchange traded funds (ETFs) should take care. Choose the wrong ETF and you could be wasting your time and money.
Regulator is concerned
The Financial Services Authority last month announced it was stepping up its supervision of exchange traded products (such as exchange traded funds or ETFs, and exchange traded commodities or ETCs) over concerns that investors did not always understand these complex financial instruments.
Interest in ETFs as a generally cost-efficient way of tracking individual stock markets and investment sectors has soared in recent years. At the same time the trebling of the oil price since 2009 has made oil ETFs a popular play for investors seeking to cash in on the global boom in commodities.
Interest in ETFs as a generally cost-efficient way of tracking individual stock markets and investment sectors has soared in recent years. At the same time the trebling of the oil price since 2009 has made oil ETFs a popular play for investors seeking to cash in on the global boom in commodities.
Oil trackers that don't track
However, as the chart below shows, the range of oil ETFs from the main provider in this area – ETF Securities – has produced widely differing results, even though in theory they all track Brent Oil, one of two main measures of the oil price.
The chart shows that since October 2007, when ETFS launched its exchange traded commodities on the London Stock Exchange, the ETFS Brent 1 month oil ETF has massively underperformed the price of oil. It also shows that none of the ETFs here have kept up with the recent rises in oil prices.
Why?
On the face of it tracking oil prices shouldn't be difficult because the 'spot price' of oil – the price we hear about every day – is the price of oil futures contracts. Although futures contracts are high risk investments, they can be bought like any other assets such as bonds, shares and gold. So why doesn't owning them enable an investor to track their price effectively?
The ETFS Brent 1mth in the chart is an oil ETF that owns futures contracts for one month. As the chart shows, it doesn't do a great job keeping up with the price. The other ETFs are the ETFS Brent 1yr, which buys and hold futures contracts for a year, the ETFS Brent 2yr which holds futures contracts for two years and the ETFS Brent 3yr which owns them for three years.
As the chart shows, the more infrequently these ETFs recycle their futures contracts, the better their over-all performance. However none of them have kept up with oil price increases seen over the last few months.
The ETFS Brent 1mth in the chart is an oil ETF that owns futures contracts for one month. As the chart shows, it doesn't do a great job keeping up with the price. The other ETFs are the ETFS Brent 1yr, which buys and hold futures contracts for a year, the ETFS Brent 2yr which holds futures contracts for two years and the ETFS Brent 3yr which owns them for three years.
As the chart shows, the more infrequently these ETFs recycle their futures contracts, the better their over-all performance. However none of them have kept up with oil price increases seen over the last few months.
The illusion
The problem investors need to get their heads around is that there is no continuous oil price. Oil futures, which are the basis of the oil 'spot price', can be bought as much as nine years ahead of a specified delivery date. However, they only represent the 'spot price' for one month in that period.
This all-important month is the last one before the delivery date, which is when the buyer of the futures contract will see his paper contract transformed into 1,000 barrels of oil. This last month is used as a proxy for the price of oil and it is known as the 'front month'.
This all-important month is the last one before the delivery date, which is when the buyer of the futures contract will see his paper contract transformed into 1,000 barrels of oil. This last month is used as a proxy for the price of oil and it is known as the 'front month'.
The problem for ‘buy-and-hold’ investors is that attempts to capture this ‘front month’ price means buying and owning futures contracts for that one month before they expire. In other words they have to recycle their holdings 100% each month in order to keep up with the price. This ‘rolling’ of futures contracts is expensive and can wipe out any gains investors have made on the oil price.
An ETF trying to do this job faces the same problem. Rolling contracts can be particularly expensive if the market is in a state of contango, a term that means the contracts are more expensive to buy today than to sell in the future. (The opposite condition, when contracts are cheaper to buy today than sell in the future, is called backwardation will make money for an investor.)
An ETF trying to do this job faces the same problem. Rolling contracts can be particularly expensive if the market is in a state of contango, a term that means the contracts are more expensive to buy today than to sell in the future. (The opposite condition, when contracts are cheaper to buy today than sell in the future, is called backwardation will make money for an investor.)
Asd a result an ETF that holds onto its futures contracts for longer periods can reduce its costs but will no longer be tracking the ‘spot price’ of oil.
What should I do?
Different oil ETFs suit different kinds of investors. In general an investor using the one month oil ETF will be interested in short-term accuracy, not a long-term investment. For example, if an investor believes that Saudi Arabia will soon become embroiled in an Egypt or Libya-style uprising they will buy the 1 month oil ETF because it will most accurately reflect an impact on the price of oil. But if this event happens a few months later than they expected, the gains in price may have been wiped out by the cost to the ETF of 'rolling' its contracts.
But if an investor takes the view that the demand for oil will continue to rise and that supply is not likely to suddenly increase, then they may prefer an ETF that reflects long-term investor sentiment. These are the ETFs which own futures contracts for longer periods.
But if an investor takes the view that the demand for oil will continue to rise and that supply is not likely to suddenly increase, then they may prefer an ETF that reflects long-term investor sentiment. These are the ETFs which own futures contracts for longer periods.
There are plenty of other ways of investing in themes like energy some of which can be found in Citywire Selection's specialist section and in the commodities section where you will find our analysts' favourite funds, ETFs and investment trusts.
A number of funds focus on the energy theme like Investec Global Energy, Guinesss Global Energy and Martin Currie Global Energy but they have all underperformed the Brent Crude 'spot price' in various degrees since April 2009 and some have under performed the 1 month ETF.
Another approach is to invest directly into oil producing companies whose share prices are influenced by the price of oil. The large ones like Shell and BP tend to be less volatile compared to the smaller ones. However there is a greater risk when investing in a single company rather than a global commodity, as demonstrated by BP.
A number of funds focus on the energy theme like Investec Global Energy, Guinesss Global Energy and Martin Currie Global Energy but they have all underperformed the Brent Crude 'spot price' in various degrees since April 2009 and some have under performed the 1 month ETF.
Another approach is to invest directly into oil producing companies whose share prices are influenced by the price of oil. The large ones like Shell and BP tend to be less volatile compared to the smaller ones. However there is a greater risk when investing in a single company rather than a global commodity, as demonstrated by BP.
Know what you're investing in
While oil ETFs may provide investors with a tighter focus on oil prices, an investor should get comfortable with how futures markets work and why an ETF will always face problems tracking them.
Nick Brooks, head of research at ETF Securities, said that information on the products was available from their factsheets which can be found on the company's website. He said that if investors had further questions they should look at the prospectus, also available on the website.
Brooks said: 'It's like buying any investment product whether its a bank account, a bond or an equity, you do the due diligence and read the descriptions of what you're buying.It's the same as buying shares in IBM, the very least you would do would be to visit the company website and work out what it does.'
He added that 80-90% of the money in ETF Securities oil products came from professional investors and that most of their cash went into the 1 month ETF because their investment horizons were rarely more than six months. However, he said that in terms of getting the best return for the risk to your money, the longer-dated ETFs were generally a better bet for longer-term investors.
source citywire.co.uk ...
Nick Brooks, head of research at ETF Securities, said that information on the products was available from their factsheets which can be found on the company's website. He said that if investors had further questions they should look at the prospectus, also available on the website.
Brooks said: 'It's like buying any investment product whether its a bank account, a bond or an equity, you do the due diligence and read the descriptions of what you're buying.It's the same as buying shares in IBM, the very least you would do would be to visit the company website and work out what it does.'
He added that 80-90% of the money in ETF Securities oil products came from professional investors and that most of their cash went into the 1 month ETF because their investment horizons were rarely more than six months. However, he said that in terms of getting the best return for the risk to your money, the longer-dated ETFs were generally a better bet for longer-term investors.
0 comments:
Post a Comment