NEW YORK ( TheStreet) -- Oil prices are soaring, but investors in United States Oil Fund (USO), have little cause to cheer. The ETF, which aims to track the price of a barrel of oil, has only recorded small gains. During the past year, the fund returned 3.8%, while the price of oil climbed more than 20%.
Part of the problem can be traced to a condition in futures markets that traders call contango. For the past several years, the problem has pulled down results of many ETFs. Now companies have introduced a number of mutual funds and ETFs that are designed to reduce the impact of contango. Funds that have opened recently include United States Commodity Index Fund (USCI), United States 12 Month Oil Fund (USL), and Van Eck CM Commodity Index Fund(CMCAX).
Contango plagues some ETFs because of the way they are structured. Instead of holding actual oil or other commodities, the ETFs trade futures. Each month the portfolio managers buy futures contracts that that represent bets on the price of oil in 30 days. Near the end of the month, the managers sell the contracts and buy new one-month futures.
Say the price of the old one-month future is 100, and the cost of the next 30-day contract is 101. The portfolio manager must sell the old contract and then invest in a new contract with a higher price. That can result in a loss, and the market is said to be in contango.Contango can be a particular problem during periods when commodity prices are rising, and investors think prices will be higher in the future. "Contango has been ongoing in recent years, but we are seeing particularly severe conditions in the oil markets now," says Kristen Capuano, marketing director of Van Eck Funds. To boost returns, Van Eck CM Commodity Index Fund (CMCAX) tracks a benchmark that was designed to minimize contango, the UBS Bloomberg Constant Maturity Commodity Total Return Index. Besides tracking one-month contracts, the index also includes contracts with maturities of 6 months, 1 year, and 3 years. The diversification helps to limit the effects of contango because the prices of the different contracts vary. Right now 3-year crude contracts on the New York Mercantile Exchange are about 101, cheaper than the 1-month contract, which is priced around 102.The benchmark sells some of its contracts every day and rolls into new ones. Because some of the trades are likely to be profitable, the new index could outperform old-style benchmarks during periods when contango plagues one-month contracts.
Select the service that is right for you!COMPARE ALL SERVICES
Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
- Weekly roundups
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Upgrade/downgrade alerts
Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.
- Diversified model portfolio of dividend stocks
- Alerts when market news affect the portfolio
- Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.
- Real Money + Doug Kass Plus 15 more Wall Street Pros
- Intraday commentary & news
- Ultra-actionable trading ideas
Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.
- 100+ monthly options trading ideas
- Actionable options commentary & news
- Real-time trading community
- Options TV