Natural Gas ETF Protects Self, Not Investors

If the fund now intends to use swaps to deliver a synthetic exposure to its original objective, this goal should be outlined up front. UNG's original strategy was complex and inappropriate for many investors. The fund's new strategy calls into question an entirely new range of risks.

The Wall Street Journal is reporting that UNG Chief Investment Officer John Highland expects regulation to affect the fund in the short term. "We just don't feel it's prudent to accept [new unit] creations and then attempt to use the money to purchase more natural-gas products when we have a strong belief that the CFTC is going to mandate limits that would either cap us or force us to reduce our holdings," noted Highland.

UNG is not the only ETF under fire. Leveraged funds such as Direxion Daily Financial Bull 3X(FAS) and Daily Financial Bear 3X(FAZ) as well as ProShares Ultra Short Real Estate(SRS) have also sparked the ire of regulators, skeptical of sales practices. A number of firms, including UBS(USB) and Ameriprise(AMP), have halted the sales of such products to their clients. The scrutiny of these funds has been led by the Financial Industry Regulatory Authority (FINRA).

The alphabet soup of regulators seems to have one goal in common: ETFs that use futures to achieve objectives may not be appropriate for most retail investors. A joint effort by the SEC, CFTC and FINRA to understand and regulate these funds would simplify the struggle.

ETFs are designed to track an underlying index through the creation and redemption of shares. Regulators or issuers that step into the flow of oncoming trading actually risk disrupting the central tenants of ETF ownership.

Traditional ETFs should be treated separately and classified apart from nontraditional products through an organized regulatory effort. If a disruption occurs, as in the case of UNG, trading should be halted until it can normally resume. ETFs are a useful tool but only when allowed to operate properly.

-- written by Don Dion in Williamstown, Mass.

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