By HCB Investment Management Investors who want exposure to the energy sector through commodities like oil and natural gas have several choices. One way is to invest in ETFs that hold futures contracts, but there are several wrinkles you should be aware of first.
Coming up short
The United States Oil fund (USO) is the largest ETF tied to oil prices, while United States Natural Gas ETF (UNG) is the largest that tracks natural gas prices. It has been well documented, however, that while these ETFs do a good job of tracking prices over short periods of time, they have significantly underperformed the markets they are designed to track over longer periods. For example, from December 31, 2010 to August 29, 2014, the prompt month crude oil futures contract rose from $91.38 to $95.96 per barrel for a 5 percent gain. Over the same period, USO declined 8.7 percent. UNG is notoriously bad in this regard. From the end of 2010 through August 29, 2014, natural gas futures contract dropped from 4.405 to 4.065 per MMBTU, a 7.7 percent drop. UNG, however, fell 53.5 percent! There are several reasons these ETFs have performed so poorly. These ETFs hold prompt month and near prompt month futures contracts, and before these contracts expire, they must be sold, and the proceeds reinvested in futures contracts that are further from expiration. This is referred to as "rolling" the futures. The process the ETFs have developed for rolling futures contracts from one month to the next is very mechanistic and transparent to the wholesale trading community, which drives this underperformance. There are other oil and natural gas ETFs which attempt to address some of these flaws, but most of them have low assets bases and are very illiquid, which limits their attractiveness to investors.