Features and Interviews
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There's
a flap swirling about the exchange-traded fund (ETF) market. Not that
that's anything new, mind you. ETFs have been viewed with suspicion
ever since Vanguard founder Jack Bogle described the then-newfangled
portfolios as "finely crafted shotguns" that could be used by investors
to shoot themselves.
The current brouhaha centers around two
oil-linked ETFs launched on the American Stock Exchange last November
by money manager Claymore Securities Inc. and MacroMarkets LLC.
Tailored
for bullish speculators or for those hedging against higher oil prices,
the Macroshares Oil Up (UCR) portfolio is designed to appreciate when
oil futures prices rise. Its complement, the MacroShares Oil Down (DCR)
portfolio, is fashioned to appeal to bears or to investors hedging
against declining oil prices: DCR's price goes up as futures on Texas
Tea fall.
UCR and DCR are inextricably linked to one another
because each lays claim to a common pool of assets. Each fund holds
short-term Treasuries and other cash equivalents, pledging to
compensate the other for fluctuations in the settlement price of the
nearby NYMEX crude oil futures contract.
Definitely not your father's Olds ... er, ETF, right?
It's
actually a fairly straightforward concept. When the up and down
portfolios pairs were initialized, both DCR and UCR shares were priced
at $60/share, approximating the price of the then-spot NYMEX oil
contract. The shares' values are geared to move as spot futures
fluctuate.
If, for example, oil futures rises $2, the DCR
trust pledges that amount plus any accrued income to the UCR trust.
Thus, the value of the Oil Down shares nominally declines to $58, while
the Oil Up shares appreciate to $62. If oil futures instead decline,
the DCR shares would appreciate at the expense of the UCR shares.
So what's the beef?
Industry
gadfly (and former long-time editor of the Metals Bulletin) Greg Newton
says the Macroshares portfolios are "in serious trouble" and blames the
funds' specialist for "contributing to their absolute failure to
perform as advertised."
Newton points to substantial variances
between the Macroshares net asset values (NAV) and their market prices
as "among the largest ever seen in ETF history."
To be sure, there's been a substantial difference built up in the first two months of trading (see graph attached).
Discrepancy, though, is in the eye of the beholder.
If
you plot UCR--the Oil Up portfolio--performance against the spot (not
futures) market price for West Texas Intermediate (WTI) crude oil, the
benchmark for the competing United States Oil Fund (USO), there appears
a cavernous rift. Spot WTI oil declined 14.2 percent between November
30, 2006, and January 30, 2007. UCR's market price declined only 2.6
percent over the same period, though its net asset value (NAV) dipped
9.5 percent.
Despite a contemporaneous 11.2 percent uptick in
its NAV, the Oil Down (DCR) portfolio's market price rose by only 2.9
percent through January.
But you shouldn't make that
comparison, according to MacroShares managing director Bill Belden. The
reason is that MacroShares aren't benchmarked to spot WTI oil like USO;
the MacroShares bogey, instead, is the nearby NYMEX crude oil contract.
MacroShares
portfolios are tracking their reference price exactly as designed,
according to Belden. Indeed, he's right. Both UCR's and DCR's NAV have
r-Squared correlations to the NYMEX nearby contract that exceed 99
percent, an even tighter fit than the 98 percent coefficient describing
the relationship between USO's NAV and its spot WTI oil benchmark.
But
investors don't trade at NAV. ETF shares change hands at prices
influenced by other forces, including supply and demand. Most of the
disparity between the MacroShares NAVs and their market prices, says
Belden, can be traced to "contango," the inherent difference between a
commodity's price for immediate versus later delivery. Despite the
relatively short throw between an oil delivery now and a delivery
through the nearby futures, there's still price spread. Contango
reflects the cost of storing and, if necessary, financing and insuring,
a commodity until delivery. The r-Squared correlation between the spot
WTI oil price and the NYMEX nearby futures is now 91.3 percent. And the
coefficient relating UCR's market price to the NYMEX contract? Also
91.3 percent, a perfect reflection of the futures market contango.
“It’s no consolation to shareholders, I know, but the NAV performance shows that the product design is sound," says Belden.
Part
of the premiums and discounts from the funds arise because, while the
products technically track the nearby NYMEX futures, they don’t
actually hold that contract in the portfolio. As mentioned, they hold
Treasuries, and promise to compensate one another for changes in the
price of the contract over time.
But while the NYMEX futures
contract expires each month, the Macroshares continue into the future.
And so, it appears, investors are pricing in the long-term contango of
the futures contracts. Rather than simply mimicking the nearby
contract, they are blending and discounting the value of the contract
out a number of months. This shows up as a failure to track the NAV,
but in reality, the funds are just highlighting a longer-term
approximation of the value of a rolling futures position.
Some
of the premiums and discounts we’ve seen over time have been exactly
that: short-term premiums and discounts due to supply/demand
imbalances. But at other times, the premiums and discounts have simply
been a way of ... well ... discounting changes in the roll yield over
time.
The Wider World - A Survey of Current Opinion and Research
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