ETFs found themselves at the epicenter of the crude oil collapse.
The unprecedented move into negative territory forced the USO to restructure several times a dumping short term contracts to avoid imploding on its many retail investors. He also made the fund a target short sellers betting against his survival.
All of this has led some in the industry to question whether more education or warning should be demanded from companies offering ETF products that trade in futures.
The key is transparency, said Jason Bloom, who oversees the Invesco Oil Fund (DBO), USO’s first competitor fund.
While both USO and DBO have fallen sharply this year, DBO has held up against its counterpart, with a loss of 51% versus an 83% drop for USO.
“USO and DBO are similar in that they are both ETFs and both hold WTI futures, but that’s about where it ends,” Bloom said Monday on CNBC. . “ETF Edge.”
“Since its inception over 10 years ago, DBO has always used an optimization process to select the futures contracts to hold,” said Bloom, Director of Global Macro ETF Strategy at Invesco. “Sometimes they own the front end of the curve, which USO owned exclusively until several recent changes.”
This “optimization process” involves a profitability calculation on the part of DBO. Before renewing its futures contracts, the fund determines which futures contract has the best “cost of carry,” Bloom said.
“In some cases, it’s actually positive income if the futures markets are retroactive,” which happens when the current price exceeds the price of longer-term futures, he said. declared.
At present, the reverse is happening with oil prices: they are in contango, which means that longer term futures prices are higher than the spot price of crude.
“Contango means there is a negative cost, there is a burden on the investor, to maintain that term exposure over time,” Bloom said. “DBO is looking to minimize that cost in a contango market. We currently hold the March 2021 futures contract, which is pretty far off the curve, and it hasn’t really been subjected to some of these issues that we’ve seen. in front of the curve. “
This is where transparency comes in. DBO shareholders know that the ETF will hold this March 2021 contract until about three weeks before it expires, and then perform that optimization calculation and roll it over, Bloom said.
“So you have a lot of transparency about your exposure in DBO, and then you can do the math,” he said. “If you buy BOD today and that futures contract is $ 29 a barrel, you know that if you’re above $ 29 a barrel minus the management fee, you have a chance to profit. . So it just depends on your expectations and your time. Setting. “
“We think it’s the best balance between predictability, transparency and a kind of dynamic optimization,” Bloom said of DBO.
Tom Lydon, CEO of ETF Trends and ETF Database, agreed that investors should be aware of what they own when buying commodity ETF stocks.
“I think a lot of investors thought that by buying USOs they could profit from future oil prices when people start driving cars and flying on planes again, but what they actually bought was this. are people who don’t fill their tanks and a bunch of tankers full of oil off the coast, “he said in the same” ETF Edge “interview. “And that didn’t translate to them. So,… you have to look under the hood.”
Todd Rosenbluth, senior director of ETF and mutual fund research at CFRA, echoed this point in the same interview.
“These types of products that use futures are more dangerous for investors,” Rosenbluth said. “It is more difficult for them to understand what they really have.”
Rosenbluth pointed out that while USO is slightly cheaper to own than DBO, with an expense ratio of 73 basis points versus 78 for DBO, it has underperformed noticeably. Over the past three years, USO has fallen 79% versus 39% for DBO.
“So you have to really understand what’s inside the wallet, how they’re different, and then figure out if they’re even right for you and your clients,” Rosenbluth said.
USO, the market largest oil ETF in net assets, fell nearly 3% in Tuesday’s session. BOD ended the day slightly lower.
Disclosure: Invesco is the sponsor of CNBC’s “ETF Edge”.