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This installment in the series about Alternative ETFs is about the energy complex. These are the ETFs that deal in the oil and gas markets (mostly) as well as their offshoots, the refined products, gasoline and heating oil. These markets affect everyone on a daily basis. And whether it's the oils spill in the Gulf of Mexico or a presidential photo opportunity to talk about the need to bring the price of gasoline down, these markets can dominate the news at times (until "news fatigue" sets in, then it is time to talk about the latest celebrity bounced from "Dancing with the Stars").
The advent of energy ETFs gives investors the ability to directly participate in these markets. While this opportunity comes with certain caveats, it is an improvement over the previous way to play the energy markets through buying the stocks of oil producers, explorers or services. As many investors can attest, the prices of these stock is only loosely tied to the price of oil, sometimes it seems, they can move in the exact opposite direction. By directly taking positions in the stated markets, the ETFs deliver what the investors should be looking for when trying to take advantage of (or protect themselves against) moves in the energy markets.
Below is a list of the top energy ETFs that had assets of $100 million or more as of the end of April. Also in the table are the returns for the last three plus years.
Now a quick look at the list lets us play our favorite game from that well-know PBS babysitter "Which of these things does not belong?" The Natural Gas fund (UNG), the Gasoline Fund (UGA) and the Inverse Crude fund (SCO) are not going to give you the direct participation in the oil market, while the others have.
Thus let's separate them and show the monthly performance from 2009 onward.
Here the charts yield no real surprise. The price of gasoline has soared over this time, while the technological breakthroughs in recovering natural gas have caused the price of that to plummet.
Short Crude oil has been a persistent loser over this time (although as you'll see in a second, this has a lot to do with the structure of inverse ETFs as well as the rise in crude).
Here, the "related" ETFs based on the crude oil market show an interesting divergence, once again highlighting the need to know what you're buying, rather than throwing money at a market blindly. We seem to have three distinct bands of ETF performance. The top band is DBO, USL and DBE. All of these have make money each year and are up from 48% to 56% over the three and a third years. OIL and USO (the latter being the big name in Crude ETFS, with twice as many assets as the next largest energy ETF as of the end of April) both lost money in 2010 and 2011, and are up 12.5% and 19.9% for the period. The third tier is UCO, a double-long crude ETF. Despite the crude market's rise, it is down 20%, having lost money every year except this year.
What does this say? The first explanation could be the guys in the first group are better at managing their fund than the guys in the second, and certainly the third. While this might be true, a closer look shows that the objective of the funds is different. Taking the relative effectiveness of the managers out, we can look at USO versus USL, which are offered by the same fund family. In USO's case, it is tracking the closest month of crude oil, until two weeks before the contract expires. USL spreads the exposure across the calendar, putting 1/12 of the fund in each of the next 12 months' expirations, and rolling only the nearest month two weeks from the expiration. By spreading the calendar risk out, the fund is far less subject to the machinations of near-term disruptions and gluts, and has the differential performance to show it.
This phenomenon is not predestined to always be so. Conditions could favor the holding of the contracts until two weeks are left, and USO could have outperformed USL, but their difference can be explained by the objective, rather than the skill of the manager. In the same way, the difference between USO and OIL is also partially objective, since OIL is trying to replicate the S&P GSCI oil index, and is subject to the rules for rolling contracts in a way defined by the index.
A separate explanation is needed for UCO. As a double long ETF, one could easily assume that it should have had blockbuster performance over this time. The worst of the long crude ETFs was up 12.5%, so (the assumption goes) this should be us at least 25% or so. Yet here is sits down 20%. On their website explaining their objective is a fairly stern warning about the management of the fund, but applicable to all leveraged ETFs (bold and italics theirs):
"This Ultra ProShares ETF seeks a return that is 2x the return of an index or other benchmark (target) for a single day, as measured from one NAV calculation to the next. Due to the compounding of daily returns, ProShares' returns over periods other than one day will likely differ in amount and possibly direction from the target return for the same period. These effects may be more pronounced in funds with larger or inverse multiples and in funds with volatile benchmarks."
So as mentioned before in previous articles, be sure you know what you are buying before you get in.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.