Oil futures were up again today reaching an intra-day high of $83.36 before closing just below $83. This year’s high at $84 is now within arm’s length and could be tested within the next trading session. These price levels also bring back memories of the summer of 2007 when oil started its ascent all the way to the all-time high of $147 in July 2008. Looking at the trend development so far, it is rather tempting to jump on the band wagon in the hope of catching a possible repeat of the triple digit prices.
Without making any prediction as to the near-term price targets at this time, I am taking this opportunity to highlight a peculiarity of certain instruments that the average investor may not be aware of. With the growing popularity of ETFs, there are now various ways to express an opinion and create exposure to various assets classes, which not too long ago, had been outside the realm of an average investor. These days, it has become seemingly as “easy” as buying a stock. One must caution however, that some of the recent ETFs tracking specific asset classes are not meant to be long-term instruments. Examining the United States Oil Fund (USO) as an illustration, the fund sponsors note that:
The United States Oil Fund, LP ("USO") is a domestic exchange traded security designed to track the movements of light, sweet crude oil ("West Texas Intermediate").
As always, it pays to understand the true nature of the investments you are engaging in and the prospectus along with all disclosures should be read prior to considering any investment in ETFs. In reality though, very few people take the time to read a complicated 128 page document such as the Prospectus for the USO. In this case, it is critical to understand that the fund only seeks to match “daily returns”, a slight nuance in the terminology which can have a significant impact when comparing the returns with the underlying asset over a longer period of time. Instead of examining some boring formulas, please consider the charts below comparing the returns of USO with the underlying oil price, that of West Texas Intermediate Futures. In the near term, the USO seems to match the returns of oil futures close enough, albeit certainly not perfect. Yet, with a longer time period, the performance turns significantly lower. In the 12 months up to March 17, the oil price is up 65% whereas USO is up only 35%.
|Oil vs. USO -YTD||Oil vs. USO - Past 12 months|
This illustrates how vast the difference can be between perception, what some industry professionals call the “naïve expectation”, and actual performance. USO and similar ETFs may be perfectly suitable investments for some investors. However, one should be fully aware of the true nature of an ETF’s holdings and should carefully consider the cost of holding the investment for an extended period of time.