When molding their portfolios, some investors seek to identify short-term inefficiencies, tilting holdings towards regions, sectors, or individual stocks that seem poised to outperform in coming days or weeks. Others seek to identify long term, macroeconomic trends that could result in favorable developments for certain asset classes. Countless successful examples of this second strategy have played out historically; investors who successfully identified the impact of Ireland’s low corporate tax rates in the 1990s or the effect of continued urbanization on Chinese markets in the 2000s recorded impressive gains (see The Case For The Ireland ETF).
In 2008, investors began identifying another shift in macroeconomic fundamentals; the gradual shift towards clean and abundant energy sources and away from imported oil seemingly made natural gas a “can’t miss” investment pick. As the mainstream media picked up on the potential for a surge in use of natural gas and some high profile and deep-pocketed proponents began promoting the “fuel of the future,” investors began scrambling to figure out the best way to get in on the anticipated boom.
One of the most popular options for investors looking to achieve exposure to natural gas prices is the United States Natural Gas Fund (UNG), which currently has about 425 million shares outstanding and total assets of about $3.1 billion. While UNG offers the closest thing to spot price exposure available, it also has some drawbacks that have caused investors to investigate potential alternatives. Specifically, some investors have become frustrated with the nuances of a futures-based strategy, noting that the “uphill battle” they often face makes it difficult to generate a positive return over the long term, even if prices of the underlying commodity steadily rise (see What’s Wrong With UNG?). After UNG lost more than 50% of its value in 2009–despite the fact that natural gas prices finished the year about where they began–the search for a new way to profit from increased usage of natural gas intensified (see FCG: A Better Natural Gas ETF?).
Under The Hood Of WCAT
In 2009, interest in exchange-traded commodity products surged, and cash inflows topped $30 billion. Options for establishing commodity exposure through ETFs have expanded rapidly, with some investors embracing equities of commodity producing companies as a “contango-free” alternative (see What Every Investor Should Know About Commodity ETFs). The Commodity Producers Equities ETFdb Category now consists of 19 ETFs with aggregate assets of more than $10 billion, including ETFs focusing on miners, timber, steel, and agribusiness.
One interesting option for investors looking to gain indirect exposure to natural gas is the Jefferies TR/J CRB Wildcatters Exploration & Production Equity ETF (WCAT), a fund that focuses on a unique corner of the energy market. The term “wildcatter” originated in the early oil industry in western Pennsylvania, where it was used to refer to a person who drills wells in areas not known to be oil fields in hopes of making a new discovery. WCAT seeks to replicate the performance of the Thomson Reuters/Jefferies CRB Wildcatters Energy E&P Equity Index, a benchmark that includes U.S. and Canadian companies engaged in the production and distribution of oil and natural gas.
WCAT’s components include small cap energy companies, a corner of the investable universe underrepresented in most portfolios. While many of the fund’s individual holdings are currently engaged in the extraction of oil and natural gas others are at a much earlier phase in their life cycle, with operations consisting primarily of exploration. As such, individual wildcatter stocks can be quite volatile; the discovery of a new oil or gas field can send share prices skyrocketing, while unsuccessful attempts can lead to bankruptcy. So the diversification inherent in an ETF (WCAT has about 60 individual holdings) is a clear benefit when accessing this targeted and risky asset class.
By country, about 62% of the ETF goes to U.S.-listed companies, with the remainder allocated to Canadian firms (see WCAT holdings). The market cap breakdown of WCAT is also noteworthy; about 32% of the fund is in mid-cap stocks, with the rest split between small and micro caps.
Although the recent economic downturn likely exacerbated the decline in natural gas prices, many analysts have attributed the slide primarily to surges in supplies of the natural resource. Several massive natural gas discoveries in recent years have significantly increased proven reserves, adding downward pressure to market prices in the process.
WCAT is an interesting way to play an anticipated increase in the market share of natural gas as a source of energy in the U.S. because the fund offers exposure to companies that are actively searching for the next big discovery. While investors in UNG are betting on strength in natural gas prices, WCAT offers a way to gain exposure to companies that may benefit from increased adoption of natural gas as an energy source, regardless of where prices head.
A quick look at some of the major holdings in WCAT highlights the potential opportunity. St. Mary’s Land & Exploration Company (SM) is focused on the exploration, development, and acquisition of natural gas and crude oil. Progress Energy is currently applying and refining technologies to recover the massive natural gas reserves in place in Canada. These companies represent the next generation of the energy sector, focused on discovering new reserves. So in a way, the components of WCAT are responsible for waves of new discoveries that have created downward pressure on natural gas prices.
WCAT vs. UNG
WCAT and UNG are vastly different products, and each will exhibit a unique risk/return profile. For investors who believe that natural gas prices will get a short-term bump, WCAT might not make a lot of sense. And the fund’s focus on relatively risky small and micro cap stocks may make it inappropriate for some conservative investors. But for those looking to make a wager that natural gas will be a major piece to the U.S. energy, the Wildcatter ETF might make a lot of sense.
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Disclosure: No positions at time of writing.