The United States Natural Gas Fund (UNG) has been one of the most perplexing exchange-traded products of 2009. The fund has lost almost 60% so far this year, but has seen cash billions of dollar in cash inflows ($5.4 billion through November, well more than the $4.0 billion in total assets the fund had at the time). So when U.S. Commodity Funds introduced a 12 Month Natural Gas Fund (UNL) in mid-November, it seemed like a “can’t miss” product, a fund offering exposure to the same commodity without some of the drawbacks that have led to the poor returns [see more information on UNL's fundamentals page].
UNG vs. UNL
UNG and UNL are very similar in many respects. Both invest (primarily) in futures contracts on natural gas traded on the NYMEX. Both “roll” their holdings as they approach maturity, in order to avoid taking physical possession of the natural gas for which the fund clearly has no use [see fundamentals of UNG here].
But the composition of these futures contracts is very different. UNG invests primarily in near-month futures, rolling these contracts to the second month as the expiration approaches. UNL also invests in near-month futures, but also in futures for the following 11 months, resulting in futures contracts for 12 consecutive months. When the near-month contract nears expiration, it is sold and the proceeds are used to purchase a far-month contract [see more information on UNL's fact sheet].
So the level of turnover shown by UNL is not nearly that of UNG, which essentially flips its entire portfolio monthly. UNL, on the other hand, turns over about 1/12th of its portfolio every month (sign up for our free ETF newsletter for more looks “under the hood” of hot ETFs).
Pros And Cons
There are both advantages and disadvantages to the strategy employed by UNL. On the one hand, the lower level of turnover has the potential to reduce expenses and the “roll yield” that must be incurred every month in order to avoid taking possession of natural gas. Because the natural gas futures curve is upward-sloping, near-month contracts are generally sold for less than the price of second-month contracts (see What’s Wrong With UNG? for a look at exactly how this phenomenon erodes returns). In such an environment, the yield incurred by UNG can eat into any returns from rising gas prices or exacerbate losses from a decline in prices (it should be noted that the curve isn’t always upward-sloping though). UNL incurs a similar yield, but because it only rolls a small portion of its inventory every month, the costs can be significantly lower.
Moreover, due to the massive size of UNG, there is some worry that the fund is flooding the market when it rolls, sending depressing prices on the contracts it is selling and boosting prices on those it is buying. Again, because UNL rolls only a portion of its holdings, this effect should be reduced significantly.
On the other hand, however, long-dated futures contracts may not be as responsive to changes in the spot price of natural gas, meaning that UNL could lag UNG if there is a steep run-up in gas prices (as shows below, this was the case last week). So if you’re expecting an imminent spike in gas prices, UNG may be the preferred option, while those with a longer horizon may be best served to go with UNL [see technical analysis of UNL here].
USO vs. USL
The concept behind UNL has been implemented before, and with great success. After the United States Oil Fund (USO) became one of the most popular ways to play oil prices, USCF launched the United States 12 Month Oil Fund (USL), which invests in 12 consecutive month crude oil futures contracts. USL has not been nearly as popular as its peer (about $150 million in assets through the end of November, compared to more than $2 billion for USO), but those who have invested in the fund have no doubt been pleased. USL has outperformed USO by about 17% in 2009, and has come much closer to tracking changes in the price of crude oil than its counterpart (though it still trails the hypothetical return on spot oil by a wide margin).
UNL launched in mid-November, and in its first month of trading has grown to about $32 million in assets, an impressive tally over the first 30 days. In the weeks following its inception, UNL initially outperformed UNG by a few hundred basis points, but the gap has closed recently, as jumps in natural gas prices following inventory announcements and the Exxon/XTO deal sent spot prices higher.
|As of 12/16/09|
One other interesting observation: while UNG continues to trade at a premium to its net asset value (this pattern has been the topic of considerable discussion among investors), UNL is actually trading at a slight discount.
It’s still far too early to tell just how popular UNL will become, and whether it will begin to attract investors away from UNG. Stay tuned in the coming months, as the relationship between these two natural gas funds will be closely monitored [see more information on UNG's fact sheet].
Disclosure: No positions at time of writing.