by Paul Weisbruch
On Wednesday June 9th, we updated our clients about a potential long oil (the commodity, not oil-related equities trade, and afterwards captured the gist of the idea here on our Seeking Alpha instablog (see Wednesday, June 9th comments)
At Street One Financial, we regularly speak with the ETF issuers in order to understand their products thoroughly, and how they should ideally be positioned within portfolios. This also helps our ability to efficiently price and trade these ETFs, as "looking under the hood" is essential to fully comprehending every ETF in the growing product universe.
We spoke with Emerging Global Shares about one of their ETFs that had caught our eye, EEO (Emerging Global Shares Dow Jones Emerging Markets Energy Titans). We have wrapped together a few points below that should be made about this fund as a potential long play on oil-related equities, from an emerging markets standpoint. And for those who "won't touch BP (NYSE:BP)" or related U.S. oil equities like Halliburton (NYSE:HAL) or Transocean (NYSE:RIG), EEO has potential because of its unique exposure to emerging markets oil names.
1) Contango is very wide
If you are investing in energy by rolling futures or using an ETF that does it for you, the cost of the roll has gotten extremely expensive. Below is the WTIC curve (These numbers are from a few days ago but you get the point) An investor rolling one month futures is losing roughly 1% a month on the roll before they factoring in the cost of purchasing the exposure. This causes a hurdle every month just to break even.
2) Non $ exposure to energy companies.
As the price of oil and other energy commodities goes up, often the dollar falls (as most these commodities are priced in dollars). If you invest in foreign oil companies, as an example, you often receive the full trade of rising oil prices and a lower $US. I.E. - Oil up, Company revenue up, share price up, as well as dollar down, foreign currency (real, ruble, rupee, etc) up.
3) Political risk
Political risk has traditionally been a label used to reference uncertainty around the regulatory stability of companies in the emerging world. Given the events over the past few months, the developing world has much more regulatory and political uncertainty for energy companies than emerging markets. The BP disaster turned public sentiment swiftly against the western oil companies, making the potential for windfall profit taxes to fund massive developed sovereign debt gaps more likely. While emerging governments with trillions in foreign currency reserves know that affordable energy is the key to sustained higher GDP growth. Often times the largest emerging market "public" energy companies are significantly owned by the government themselves (Petrobras (NYSE:PZE), China petrol, Lukoil (OTCPK:LUKOY), etc) thus they would be taxing themselves.
4) Active hurricane season
Experts have noted in several public studies that warm waters in the Atlantic are setting the stage for a potential severe hurricane season in the Eastern United States. This generally is accompanied by a spike in energy prices.
Most investors may pull up a chart in EEO and note low daily trading volume, relatively low "visual liquidity" on the inside bid/ask, as well as a bid/ask spread that can be particularly wide at times. We have priced this ETF before in good size, in between the prevailing bid/ask that you will see on the screen, so the underlying basket is more liquid than meets the eye. As with all ETFs, and a point that we make to everyone that we speak with, liquidity is not trading volume, and trading volume is not liquidity. (Many heavily traded ETFs trade sloppily as far as real price slippage. VXX, for example, on a few thousand shares.) Whereas some thinly traded ETFs can be priced very "tight to the screens" on sizes that may be large multiples of the average daily trading volume. This said, it pays to understand what is "in" the ETF that you are considering, what is your portfolio objective, and finally "how well will this ETF deliver on this objective" before potentially dismissing something because of low trading volume.
Some look at expense ratios as "final determinant" in deciding to purchase a given ETF as well, and this isn't as black and white as most believe. Some ETFs are structured as alpha vehicles, some track their stated indexes better than others, some are simply more innovative than a cheaper, older vehicle. That said, not all ETFs are priced at 9 or 10 basis points, but many are much higher because they may potentially deliver something that the cheapest options out there may not. This relationship is the same as in any industry, whether you are buying an automobile or a box of corn flakes. Sure the Daewoo is much cheaper than the Mercedes, but is the Daewoo automatically, in all cases, the best choice for the car buyer on the basis of price? Is the box of store brand, generic Corn Flakes always, under all circumstances the better choice than the Kellogg's brand Corn Flakes? Be sure to address this before making that final decision on which ETF to buy.
Disclosure: No positions