ETF issuers are under pressure to react quickly to the historic turmoil in oil prices as exchange-traded products offering exposure to the asset class face the increasing risk of forced liquidation.
The first signs of concerns among ETF issuers came when the USCF Investments, owner of the world’s largest oil ETP, the $3.4bn United States Oil Fund (USO), filed with the Securities and Exchange Commission (SEC) to change its investment strategy on 17 April.
The firm announced it was shifting 20% of its assets to second-month futures contracts having previously been exclusively invested in the front-month citing market and regulatory factors.
Then, following the turmoil in oil markets which saw West Texas Intermediate (WTI) trade as low as $-40 a barrel, UCSF announced another change which allows USO to invest “in any month available or in varying percentages”.
The dramatic change in approach, which now means USO is effectively an active strategy, highlights just how concerned the firm is about short-term prices and the divergence between crude futures and those for the following month – known as contango – that is occurring.
The vast majority of ETPs – most likely all – managed to avoid the huge drop in May futures contracts as they had already rolled them onto June and July.
However, a big concern for ETF issuers is if the June contracts also hit $0 as this will make their strategies worthless.
As a result, BetaShares has also changed its investment strategy for the $90m oil ETP (OOO) by using three month oil futures instead of one month in order “to reduce the risk to the fund of the June 2020 futures contract trading at a negative price (which would reduce the fund’s value to zero)”.
WisdomTree, which has Europe’s most extensive oil ETP range, has been forced to close a number of its leveraged ETPs due to wild swings in prices.
is yet to reveal whether it has taken the same action on its products.
A number of questions arise from these changes. It is unclear whether ETF issuers should have the power to change an investment strategy when the product is designed to track an index.
If the June contracts were not to expire and in fact rebound, for example, then investors would miss out on the upside having previously been impacted by the 81% fall in oil prices this year.
This is an active bet the ETF issuers are making which is the role of the investor, not the provider. If investors are worried about the June contracts going negative, then surely they can sell their exposure?
However, one could certainly make the argument that it would be even more irresponsible for investors to be left fully exposed to the June futures market which is already showing signs of collapsing.
The moves highlight ETF issuers are prepared to be nimble during periods of abnormal market conditions and this could benefit investors who may not have fully understood the risks involved when gaining exposure to the oil futures market.