Natural Gas ETF Clock Ticking

The SEC will likely approve the 1 billion extra units for the U.S. Natural Gas Fund (UNG), paving the way for more investors to gain exposure to the natural gas market. The last few weeks have been a whirlwind for UNG traders as the popular ETF has essentially operated as a closed-end fund pending the release of the new shares.

As creation of UNG ground to a halt, both traders and regulators were faced with the reality of the fund's influence on the commodity it was designed to track. UNG was forced to stop selling new shares July 7 because it reached the limit of shares it was approved by regulators to create. UNG assets have gone from about $400 million in January 2008 to almost $4 billion.

The creation and redemption process helps keep ETFs in line with NAV, and UNG has been disjointed from its underlying value since regulators stepped in. The fund has traded at both a premium and a discount as traders wait for the new shares to be issued.

While the additional units should help to put UNG back in line, the recent hiccough in share creation raises important questions about the fund and the ETF industry as a whole. UNG and its sister fund U.S. Oil Fund ( USO) essentially allow investors to trade commodities as if they were stocks. The question among issuers has not been "should" but rather "could" when it comes to introducing increasingly complex ETFs, and the roll strategies that underlie these funds are far more complex than many investors would like -- or want -- to wrap their minds around.

Unusual regulatory activity in funds such as UNG reflects the challenges presented by new "non-traditional ETFs." UNG should not be alone in the lineup, however, and regulators should address concerns about the leveraged funds offered by Direxion, ProShares and Rydex while they're at it. These funds have complex methodologies that are not appropriate for most investors, and the CFTC, FINRA and SEC should communicate on the future availability of these strategies.

Whether regulation causes an ETF to trade at a premium or at a discount, investors should be primarily concerned about why the fund would deviate from NAV in the first place. ETFs were designed to be transparent investment vehicles that would trade for the price they were worth. While traditional equity-based ETFs accomplish this task quite well with healthy investor interest, a new generation of more complex funds are being introduced and, in some cases, misunderstood.

Regulators should focus on the categorization and appearance of new more complex, ETF products. As ETFs vie with mutual funds for retirement assets, there is no time to waste.

At the time of publication, Dion had no positions in the funds mentioned.

Don Dion is the publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.

Dion is also president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

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