When it comes to commodity investing, there is perhaps no corner of the market more popular than oil. Investors and traders alike have long embraced the fuel for its inherent volatility and lucrative return potential. And whether investors choose to capture exposure through futures or equities, the ETF industry certainly has several compelling options. Adam Patti, Chief Executive Officer and Founder of IndexIQ, recently took the time to discuss IndexIQ’s IOIL, highlighting how investors can benefit from investing in the small-cap corner of the oil industry [see also Select Sector SPDR ETFs Head-To-Head].
ETF Databse (ETFdb): What was the inspiration behind creating the IQ Global Oil Small Cap ETF (IOIL)?
Adam Patti (AP): There were a couple of things. The first was that when people want to play oil they are using a lot of vehicles out there that are actually not the best proxies for spot oil price, which is generally what investors are looking for. Typically they are buying one of the large cap energy funds, but energy is much broader than just oil. What you will find is that natural gas and oil move very differently, so you aren’t getting great exposure there. The other tool often used to gain access to oil is derivatives, but if you look back, these products have actually not tracked oil very well because of contango or backwardation in the market place. So we thought it was important to make a product that was pure oil and actually tracked the spot oil closest and after looking into the returns of various oil investments, we found small-caps actually track the price best [see 3 Things You Need To Know When Picking A Commodity ETF].
ETFdb: What is the appeal of investing in small cap oil companies versus more well-known, established corporations like Exxon (XOM)?
AP: Through small cap companies you are receiving pure oil exposure that the large caps do not have. There are other benefits as well; small caps are excellent merger or acquisition candidates for the larger companies that are always looking to gain new access to production, refining or distribution. We have already seen a number of acquisitions of companies in the index, which is always a nice benefit. But I think that one of the most important things we found in the commodity ETF sector, whether its large cap energy or big agribusiness, is that they are not really providing the diversification that they would have years ago. With so many billions of dollars flowing into these large cap funds, which are typically pretty concentrated in the top ten holdings, we found that most diversification benefits have been significantly reduced. With small caps an investor receives the diversification benefits they may have received years ago with the large cap companies, and with significantly smaller cash flows chasing these companies, the investment flows are not pushing the valuations of those securities around the way large caps are [see Energy Bull ETFdb Portfolio].
ETFdb: Would you consider IOIL more of a compliment or an alternative for someone who already owns or is thinking or buying a broad, large-cap energy sector ETF?
AP: The reality is that large cap energy ETFs are dominant products in the market space and there is pretty wide spread ownership of these products, so we would say our product is a great complement to them. You can keep your large cap exposure for a broader energy class, but IOIL is a strong pure oil hold. For investors looking for the best way to invest in the spot oil in the market place, there really is no comparison to IOIL in the existing market. IOIL and has been one of the top performing energy ETFs since inception, with a closer correlation to the price of spot oil. We may be seeing an excellent entry point for IOIL right now, in part because the price of oil has come down recently, however we are seeing increasing upward price momentum due to the turmoil wracking the middle east. IOIL is a more effective way to play rising oil prices because the fund isn’t clouded by the trend lines of other types of energy that some ETFs are being driven by.
ETFdb: Broadly speaking, what are some other long-term trends that you are seeing in the global energy market?
AP: I think oil should be a core holding in portfolios. We have continued population growth and a finite number of oil wells that are being drilled, so we have a slowing supply base with growing demand. From an investor perspective the long term trends for oil are strong. While we certainly hope there are alternative energy sources that become more prevalent in the future, for now, oil is driving the economy of the world and IOIL is the only pure play for the sector [see What Can You Buy With America's Daily Oil Consumption?].
Bottom Line: When looking to add exposure to the oil industry, many investors are quick to choose big name companies like Exxon and Chevron. Index IQ’s IOIL, however, offers a compelling option for those looking to benefit from smaller capitalization oil companies with more attractive growth potentials.
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Disclosure: No positions at time of writing.