For advisors utilizing ETFs in client portfolios, the details matter. Whether it be the difference in product structure, weighting methodology, or degree of currency exposure, seemingly minor details often end up having a rather significant impact on bottom line returns and overall volatility. The importance of nuanced elements of product structures is particularly important when it comes to commodities: the choice between ETF and ETN can have a major impact on tax consequences, and the composition of broad-based commodity ETPs between the various families can result in very different returns [see Special Report: In Search Of The Best Commodity ETP].
Even within single-resource ETPs that utilize similar structures, the manner in which exposure to the underlying product is achieved can end up being quite significant. Products implementing futures-based strategies–which includes the majority of commodity ETPs–often vary in the duration of their underlying holdings and the frequency with which those holdings are “rolled” to avoid taking delivery of physical commodities.
The performance of two oil ETFs in January illustrates how the differences in portfolio turnover and duration can lead to disparate returns–even over a relatively short period of time. Both the United States Oil Fund (USO) and Teucrium Crude Oil Fund (CRUD) invest in Texas Light Sweet Crude Oil futures contracts traded on the NYMEX, but the composition of the portfolios differs with respect to the time to expiration of the contracts (USO also uses ICE contracts on occasion).
In January CRUD outperformed USO by nearly 200 basis points, the result of the differing maturity structure between the two:
USO focuses on front-month contracts, rolling to second month futures as expiration approaches. CRUD spreads exposure across three different maturities: nearest-to-spot June or December (35%), the June or December contract following the aforementioned contract (30%), and the December contract following (35%). Currently, the USO portfolio currently consists of March 2012 NYMEX futures, while CRUD holds contracts expiring in June 2012, December 2012, and December 2013. CRUD’s structure proved advantageous in January, in part because of the lower turnover that comes along with this strategy [see also Understanding Contango].
Different Vehicles For Different Purposes
While CRUD had the clear edge last month, it shouldn’t be implied that the Teucrium fund is the right choice for all investors seeking out exposure to crude oil. Rather, the different structures used by the various products make each useful for different investment objectives. The focus on front-month futures maintained by USO makes that fund efficient at mimicking short-term movements in the spot price of crude oil; because front month futures have a higher correlation with spot than longer-dated contracts in the short term, USO will tend to respond pretty well to day-to-day movements in crude [see Energy Bull ETFdb Portfolio].
Over longer periods of time, however, the impact of frequent rolls can become more pronounced, with contangoed markets eating into returns. Because CRUD rolls its holding only four times per year (and rolls only a portion of assets on those occasions), the adverse impact of contango is considerably diminished. That might make CRUD a more effective tool for investors looking to achieve exposure to oil prices over a longer period of time.
Disclosure: No positions at time of writing.
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