Natural Gas ETF: Hazardous Trading

NEW YORK (TheStreet.com) -- The latest chapter of the U.S. Natural Gas (UNG) saga raises an important point about ETF trading. The halt in UNG's creation process has caused the fund to trade at a ridiculous 11% premium and the fund should be ashamed to call itself an ETF.

It is the creation and redemption process that makes ETFs unique, and stripping them of this ability is like gutting a central premise. Wait -- there's a name for funds that have a fixed amount of units: closed-end funds.

Liquidity is an important measure of viability when examining an ETF. A consistently high trading volume generally indicates a high level of investor interest. This makes it easier for investors to buy and sell shares in the open market.

Stop Trading UNG

UNG certainly does not lack in this category. Despite the fund's stunted status, millions of shares of the fund are still trading hands.

Trading in UNG should be halted immediately and stay halted until this fund can get back on track. ETFs are not only designed to track an index, but to do so transparently.

"Transparent" is hardly a word that one can use when describing the current state of UNG. The fund's refusal to create additional units is an admission that the fund managers are not sure of what the fund's investment strategy should be.

UNG is currently examining investment alternatives for the fund's assets. Managers have been buying swaps and unloading soon-to-be-regulated futures contracts. A halt in trading would allow UNG managers to wait for answers from the Commodities Futures Trading Commission (CFTC) and come up with a game plan.

Regulators are changing the rules midgame with UNG. They have taken the wheels off of the UNG bicycle and then patiently asked it to continue rolling down the street. This dangerous, unwieldy fund will continue to be a safety hazard.

UNG managers can not be blamed for not wanting to create additional shares. The ongoing CFTC debate will bring new regulation, likely in the form of position limits, which will paralyze UNG's current creation process. The rules are about to change again, and UNG is skipping its turn until they've been established.

The continued trading of this fund is a public health hazard that must be addressed. Without the creation process, this fund can not trade as advertised -- a lawsuit that is just waiting to happen.

It is the creation and redemption process that keeps a fund's market price in line with its underlying value. In an age of electronic trading and high volume, extreme premiums and discounts should be viewed with a skeptical eye.

In the last month every regulator in the book has wanted to scrutinize the booming ETF industry. It's time for one of them to do the right thing and call a time out before someone gets hurt.

-- written by Don Dion in Williamstown, Mass.

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

Don Dion is 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.

Dion also is 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.

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