What Does UNG Really Track?

As potential regulation cramps U.S. Natural Gas(UNG) style, fund issuers may turn to new, less-regulated methods to keep their fund afloat. Average investors should avoid UNG until the storm blows over. Sophisticated investors, on the other hand, must ask themselves: What does UNG really track?

Currently, UNG's stated objective as found on its Web site is to track "the changes in percentage terms of the units' net asset value to reflect the changes in percentage terms of the price of natural gas delivered at the Henry Hub, La. But regulation may soon dictate that UNG managers will be limited in how many of these contracts that they can buy.

UNG managers reacted to this potential regulation last week by scaling back their position in these futures contracts. In the past, U.S. Oil(USO) has faced similar challenges with the same response. UNG managers, who have been awaiting since June the approval of 1 billion extra shares, also announced that they may not seek to create all, if any, additional shares.

Problems abound in ETFs when a fund is not allowed to track its stated objective. If UNG declines to create more units, or regulation redefines the way in which it can create more units, it is likely that the fund will continue to stray from NAV. During June, natural gas inventory hit a new high while UNG fell 5%.

Fear not, potential customers -- UNG will formulate an alternate strategy to get units out the door. During the second day of the Commodities Futures Trading Commission (CFTC) hearings last week, an 8K filing from UNG was highlighted, underscoring the willingness of the firm to seek investment alternatives outside of the fund's stated objective:

"The Nymex [natural gas] futures contracts and the LD1 contract, the economic equivalent of UNG's benchmark futures contract, have to date provided the best means for UNG to meet its investment objective of tracking percentage changes in the price of the benchmark futures contract. However, UNG has been forced to consider other investment alternatives in order to avoid violating these new limits and to avoid regulatory action."