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Matt Hougan Analyst Blogs

Five Good ETF Ideas That Haven’t Caught On (Yet)

Related ETFs: USO | USL | HAO

You know, like the HealthShares Ophthalmology ETF (NYSEArca: HHZ). The idea that $200 million in assets would flow into ophthalmology companies was prima facie absurd, something the fund's developer—XShares—has now recognized, as the fund is being liquidated on September 19.

But for every ophthalmology ETF, there is an ETF backed by a good idea that never catches on. I might count the HealthShares Cancer ETF (NYSEArca: HHK) among them. Cancer is a legitimate subclass of the healthcare industry; an area where tons of new money and legitimate scientific breakthroughs are changing the way we treat a disease. I'm not making allocations to cancer in my portfolio, but I wouldn't fault somebody who did.

With that in mind, I thought I'd look at the list of ETFs with very little assets to see what gems lie beneath the rubble. To make it fun, I thought I'd highlight only funds with less than $10 million in assets as of July 31, 2008. In some cases, the funds have just launched and haven't had enough time to attract assets; in other cases, they've languished on the market for years.

This is not a recommendation to buy any of these funds, which have some flaws and don't belong in every portfolio. But it is a reminder that there are some interesting funds out there that people pass up.

Good Funds With Less Than $10 Million In Assets

1) United States 12 Month Oil (AMEX: USL): People love to invest in oil using ETFs. The United States Oil Fund (AMEX: USO) has over $1 billion in assets, and has become the retail trading vehicle for crude.

The United States 12 Month Oil Fund, however, has attracted just $7 million since launching late last year. That's odd, as you could argue that USL is a better proxy for the oil market than USO.

The difference is this: USO follows the "classic" method of investing in the oil space. It buys the near-month crude oil futures contract and then rolls that position over month-to-month. For example, right now, USO holds oil contracts expiring in October; before those contracts expire, it will buy oil contracts expiring in November. And so on and so on.

By contrast, USO spreads its oil contracts out over 12 months: It owns a few October contracts, a few November contracts, a few December contracts, etc., right up through September of next year.

Why should you care? Because often, there's a big gap between the near-month oil contract and the second-month oil contract. This can either boost returns, if the near-month price is lower than the second-month (a situation called backwardation), or cut into returns if the near-month price is higher (a situation called contango). The impact can be large: In 2006, oil investors regularly lost 2-3% of their returns each month because the market was in contango.

In theory, USL should stick closer to the spot price of oil than USO over time.

So why hasn't it caught on? For one, it's complicated to understand the differences, and with USO coming first to market, it had a huge advantage. Moreover, right now the market is in backwardation, which means that USO should outperform USL in the short term. But things have been moving around quickly in the oil space, and just a few months ago, the opposite was true. I think over time investors may come to see the wisdom of moving back and forth between USL and USO depending on the status of the oil markets.


2) iPath Global Carbon ETN (NYSEArca: GRN)

The iPath Global Carbon Credit ETN (NYSEArca: GRN) is the only product I know of that lets you easily invest in the value of carbon credits.  The fund has performed terribly since it launched, falling 26% in July, which probably explains the low asset counts. But the idea of tapping into this fast-growing market still strikes me as appealing.

The problem, I suppose, is that few people know how or where GRN would fit into a portfolio. Roger Nusbaum of has expressed surprise that the historical correlation between carbon credits and stocks is high, but that makes perfect sense to me: The value of carbon credits will increase as industrial production increases, and decline as industrial production declines, just like stocks.

Given its dismal performance since launching in early July, I'm not really surprised GRN has no assets. But I suspect that, over time, as investors come to understand this market, funds and notes like GRN will find a home.



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