Contango and backwardation. For professional commodity investors, the two terms are common knowledge. However, for regular retail investors, many are blissfully unaware of how these two situations can affect their returns – even if they own popular commodity-linked ETFs like the United States Oil ETF (USO A). In fact, the two situations can actually put investments into some pretty nasty losses.
And that’s where the relatively new ETF issuer AccuShares comes in.
The firm’s two new funds that launched on June 28th – the AccuShares S&P GSCI Crude Oil Excess Return Up Shares (OILU ) and AccuShares S&P GSCI Crude Oil Excess Return Down Shares (OILD ) – hope to eliminate many of the problems facing traditional commodities ETFs by using a unique mechanism for trading.
The Problem With Contango
The problem with many commodity-based ETFs comes down to how they roll their futures contracts. Futures contracts are constantly expiring, so funds that invest in them need to sell and purchase newer contracts in order to stay invested in whatever the commodity. The problem comes down to the two terms, contango and backwardation, mentioned in the intro.
A futures contract is said to be in contango when later-dated contracts trade at higher prices relative to contracts that are close to maturity. When a futures-based ETF sells the near-dated contract and buys the further-out one, they are basically selling low and buying high. This causes them to lose money on the futures roll and decline in net asset value (NAV).
Some futures products, such as the PowerShares DB Commodity Tracking ETF (DBC A), use optimum-rolling strategies to eliminate the effects of contango. However, those promising “near-spot” pricing will often just own the next-dated future contract on a given commodity. The popular USO is prime example of this, and the fund has constantly been a money loser for investors over the long haul.
And it’s not just commodities. ETFs that promise near-dated futures exposure to equities or bond indexes also suffer from the roll effect. The $1.5 billion AUM iPath S&P 500 VIX Short Term Futures TM ETN (VXX B+), which focuses on VIX futures, has lost more than 90% of its value since inception because of this.
AccuShares Innovative Fix
Both OILU and OILD hope to eliminate much of this. And it’s because they don’t actually own futures contracts.
The two new ETFs will own a mix of old cash, T-bills, bonds and other U.S. Treasury securities instead. How they track the price changes in the S&P GSCI Crude Oil Index is through a unique asset-swapping strategy. OILU and OILD will swap these assets back and forth based on the increase or decrease in the spot price of the index. Oil is up on Monday? OILD will hand OILU shareholders a proportionate amount of its cash and bonds. Oil down on Tuesday? The reverse happens. That basically provides spot pricing when it comes to tracking the change in oil prices.
The key for the two new ETFs is that this new indexing methodology recalibrates the ETFs on the 15th of the month and basically resets them. Investors will receive the indexes return via dividends. The idea is that these dividends are what provide the real return of oil prices rather than share price trading. Investors will get a 1099 statement rather than a dreaded K-1.
If this sounds familiar to long time ETF fans, it should. The defunct MacroShares (UMM and DMM) tried a similar asset-swap ETF model back in 2008-2009. But without the monthly reset some of its ETFs went to $0 and were forced to liquidate. OILU’s and OILD’s reset prevents this from happening.
Expenses for the two ETFs run at just 0.29%, or $29 per year for every $10,000 invested.
A Better Mousetrap if it Works
For investors, AccuShares new funds do offer the potential for a better way to play spot crude oil prices. The problem is whether or not they’ll deliver. The firms other-swap ETFs – the AccuShares Spot CBOE VIX ETF Up Class Shares ETF (VXUP ) and Down Class Shares (VXDN ) – haven’t exactly caught on with investors. You kind of need a decent asset base for the swap strategy to work. VXDN and VXUP have delivered on its promise, at least in terms of the dividends received.
That will hold true to OILD & OILU as well.
The Bottom Line
The ETFs are innovative, but it still seems that investors looking for near-term pricing are more interested in trading rather than holding futures. This will continue to push them into products like USO. It’ll be interesting to see if the new ETFs and their strategies will survive or head-off into the sunset like MacroShares.