Thursday, May 14, 2009

Risk of Oil ETFs

I have looked at oil commodities various times at the past. It is clear that any financial instrument has risk. While commodities are safer than equities, commodities are not safe. I always knew that there are risks with USO, OIL, etc. I never spent time on really understanding where the risks lie. Today I had a look at that. First we need to distinguish ETFs from ETNs. ETNs are a lot more risky (in comparison to ETFs) as a default of the issuer will cause your paper commodity to have value zero. Hence, if Barclays goes bankrupt, OIL (issued by Barclays) will have value of $0. ETFs - in theory - have some protection. If the ETF issuer fails, the paper commodity is partially backed by a real commodity and after months or years in the court and lots of paperwork the owner of an ETF whose issuer failed will get some of the invested money back. That is the easy part.

What are the risks of USO and USL? Both are ETFs. There are many risks to be found in the prospectus. Some key issues are: investment in a) swaps, b) treasuries and c) over-the-counter contracts with investment banks. When USO and USL receive money from investors, they invest in oil futures, but a portion gets also invested in swaps, treasuries, and OTC investment bank contracts. The prospectus unfortunately does not specify which percentage goes into oil futures and which remaining percentage goes into the aforementioned rest. Swaps have an elevated element of risk. One can argue that today with the US printing nearly unlimited amounts of treasuries, even treasuries are no longer safe. And that investment banks can crash we have seen recently.

More here: Risks on ETFs. Oil ETFs, and Contango and Oil ETFs.

No comments:

Post a Comment