Troubled By ETF Tracking Failures? Try ETNs

Includes: DJP, GSP, INP, OIL
by: Richard Shaw

ETFs got some bad press in the April 19 Wall Street Journal for, in come cases, failing to track the indices they were designed to follow. Victoria Bay Oil ETF (NYSEARCA:USO) and Claymore oil ETFs -- (UCR) and (DCR) -- were cited as particular cases of failure.

Most ETFs did just fine, we suspect, but these commodity oriented ETFs failed their investors. The article said the Claymore ETFs sometimes actually moved counter to the moves of their index. USO was off 15% from its index.

That’s where ETNs (exchange traded notes) come in as near perfect solutions to the tracking problem. Barclays recently began offering ETNs for commodities, as well as for India (NYSEARCA:INP). They offer an oil ETN (NYSEARCA:OIL), and two commodity ETNs, one based on the Dow Jones – AIG Commodity Indes (NYSEARCA:DJP) and one on the Goldman Sachs Total Return Index (NYSEARCA:GSP).

Their ETNs are actually debt instruments issued as liabilities of Barclays, but the principle amount fluctuates with the price levels of the underlying index. They don’t pay interest. They produce exactly the index return minus the management fee, which is more than can be said for the Victoria Bay and Claymore ETFs. Investors get what they planned for in their asset allocation.

There is an important caveat. ETNs are debt obligations and are subject to the solvency of the issuer, Barclays. This author would far rather bet his money on the solvency of Barclays over the skill of portfolio managers at Victoria Bay or Claymore.

USO is the dominant volume oil play, but OIL is so far the more dependable oil play.

Full Disclosure: Author owns DJP

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