New Futures ETFs Aim to Sidestep Contango

The vicious contango that has plagued investors in oil and energy futures finally appears to be going away, but product issuers are busy developing products that allay its impact … just in case it reappears.

A futures market is in contango when the price of a commodity for future delivery is more expensive than the spot price, i.e., when oil costs $70/barrel today but $75/barrel tomorrow. That harms futures investors relying on the traditional futures investing methodology, which holds the current month’s futures contract until it expires and then “rolls” that position into the net month’s contract. If next month’s contract is more expensive than this month’s contract, an investor effectively loses money on every trade.

The futures market periodically swings from contango to its opposite, backwardation, and there has recently been a long and vicious contango in the energy markets. Contango is to blame for the poor returns in futures-based commodities ETFs such as the United States Oil Fund (USO) or the iShares GSCI ETF (GSG): Despite the fact that oil prices are at or near record highs, investors in these funds have lost a significant amount of money over the past year, much to their chagrin.

Despite the fact that contango has been lessening of late, firms on both sides of the Atlantic have recently laid plans to launch new ETFs that aim to sidestep the contango issue.

First, as reported in ETF Watch, the developers of USO filed with the Securities and Exchange Commission [SEC] for the right to launch the United States 12 Month Oil Fund. Rather than simply investing in the near-month contract, this new fund will track the return of an equal-weighted position in the next 12 months of oil futures contracts. While not explicitly addressing the issue of contango, this strategy will reduce its impact on the fund, as that blended futures curve is traditionally less subject to contango than the near-term markets.

Meanwhile, ETF Securities – the group that brought oil futures ETFs to Europe – has announced plans to launch six new ETFs that provide even longer-term exposure to the oil markets. The funds will track the 1-year, 2-year and 3-year futures contracts for both Brent and WTI crude oil, and will trade on various European markets.

“Demand for these new ETCs is also being driven by investors searching for a means to expose their portfolio to the benefits of backwardation* which can provide a source of return in addition to the oil price return. Due to the dynamic nature of backwardation and contango, investors wish to be able to track different oil futures dependent on this feature,” the company wrote.

In other words, these ETFs will give investors the chance to look for the “sweet spot” on the oil futures curve and try to position themselves accordingly. The group said that the various strategies perform very differently over the short-term, but track closely over the long-term.

The thing about all these new products, of course, is that investors already have access to them … in the futures markets. What these ETFs are doing is making it easier for investors to tap into these markets without having to worry about the risks and requirements of futures-based investing. That’s a good thing, as long as investors simultaneously get the education they need to understand what they’re buying. That was not the case with the initial oil ETF, and investors got hurt with contango. There will need to be serious education efforts surrounding these new, longer-dated ETFs as well, to ensure that investors understand them, too.