This week we’ve fielded calls requesting information and guidance regarding ETF coverage of energy commodities. And while the entire commodity arena warrants attention, for the sake of brevity, we’ll limit our discussion here primarily to the energy segment.
Most any form of commodity exposure that the individual and institutional investor would need is currently available in the form of an ETF. And there’s more in the SEC registration pipeline that will provide additional granularity through a broader menu of single commodity ETFs during the coming months.
Commodity ETFs can be grouped along three primary lines: energy, metals and agricultural.
The most developed of the three, selection-wise, is energy. Exposure can be had across all three segments via a single ETF or can be tailored by the investor via the use of single ETFs covering individual commodities or commodity subclasses.
Construction-wise, (un-leveraged, long) commodity ETFs purchase short-maturity treasuries which are then used to collateralize ownership in commodity futures positions. Among alternatives covering a given commodity, there are important differences in how expiring futures positions are rolled to forward futures positions. This is not an issue for two of the gold ETFs, which directly hold physical gold.
Deutsche Bank Commodity Index Fund (DBC), marketed through Powershares, is 55% energy (35% crude, 20% heating oil), 22.5% metals (precious at 10% via gold, base at 12.5% via aluminum) and 22.5% agricultural (11.25% for each of wheat and corn). The fund is rebalanced back to these weightings once per year in November.
The players in energy ETFs are US Commodity Funds LLC and Deutsche Bank (DB). Energy exposure can be taken in the form of a multi-commodity ETF, comprised of refined and unrefined components, or via single commodity ETFs.
DB Energy Fund (DBE) is a mix of crude oil (45%), refined oil products (45%) and natural gas (10%). The crude component is split between WTI and Brent at 11.25% each. The refined is split between heating oil and RBOB gasoline, likewise at 11.25% each. Holdings are rebalanced to the base weights once per year in November.
On the crude oil front there are three choices – differing primarily in what futures contract(s) they hold and how they roll expiring futures positions forward.
US Oil Fund (USO) owns near futures month and rolls positions over a 4-day period.
US 12 Month Oil Fund (USL) spreads ownership across 12 months, rolls expiring month to the back.
DB Oil Fund (DBO) holds positions in a single month (currently June); between the 2nd and 6th trading days in contract expiration month the fund rolls position to one of 13 forward months depending on spreads and the application of DBs roll optimization methodology. This same roll methodology is applied to futures positions in other DB commodity ETFs.
USO might be preferred in price-strengthening environments as inter-month futures spreads tend to become increasingly backwardated (i.e., forward months trading at discounts to near months). USL or DBO might be preferred in flat-to-weakening price environments in the event that forward futures prices move to premiums over nearby months.
Others (all hold near-month futures positions)
US Gasoline Fund (UGA)
US Heating Oil Fund (UHN)
US Natural Gas Fund (UNG)
All of the abovementioned ETFs have actively-traded options available.
There are also 2x leveraged long (UCO) and 2x leveraged short oil (SCO) ETFs (issued by Proshares). These generally don’t hold futures positions directly, although their prospectuses allow this in addition to the holding of options on futures. Most positions held by leveraged and inverse ETFs are in the form of over-the-counter swaps, with third party institutional providers / market-makers, which are trued up (collateral-wise) on an ongoing basis. There are critically-important tax considerations as well as serious cumulative return dynamics that investors need to fully understand before wading into any leveraged or inverse products.
Commodity exposure can also be taken on via exchange-traded notes (ETNs) – except for options, which are not available on ETNs. Multi-commodity ETNs tend to provide exposure to broad commodity indexes having a composition mix that is variable over time. Multi-commodity ETFs typically have a base allocation schedule across commodities that is rebalanced periodically. There are a number of very important differences between ETNs and ETFs, including important aspect of ETNs being debt instruments.
We outlined the critical features both ETNs and leveraged and inverse ETFs in feature segments in our May newsletter. Please let us know if you haven’t received a copy of that letter but would like to.
For those interested in equities exposure, there is an abundance of ETF alternatives holding stocks of companies engaged in energy sector, sub-sector and industry-level activities. And many of these also are available in un-leveraged, leveraged and inverse forms.
We’ll follow up with discussion on metals, agricultural commodities and currencies – all worthy of attention.