'OIL': An Oil Fund Doomed To Fail

January 21, 2016

Observant investors may have noticed that West Texas Crude Oil is trading for less than it costs to buy the metal barrel to store it. That inevitably has some folks looking to call the bottom and go long oil, and that’s just fine: There are ETFs that can do that for you.

But there’s one particular ETF—an exchange-traded note really—that looks too good to be true, the iPath S&P GSCI Crude Oil Total Return ETN (OIL | B-92).

In the “Star Wars” words of Admiral Ackbar: It’s a trap. First, here’s the chart:

As you can see, in 2015, OIL pretty much tracked its fair value perfectly—that fair value being the S&P GSCI Oil index, which is a rolling front-month futures contract in West Texas Crude. This was a terrible investment, sure, but the security seemed to be working as it should.

Then, in the fall, just as things got really interesting in oil (Texas tea, black gold), the OIL ETN seemed to start diverging from fair value. In fact, it looked like it was miraculously avoiding the steep sell-off.

Related Article: Oil: Buying Opportunity Of A Generation?

Built-In Disaster

OIL is a terrible, terrible exchange-traded note for two reasons, both built in by design.

The first is that over the long term, your fees are going to vary wildly based on how the ETN performs. OIL is in a class of old-school ETNs with path-dependent fees.

Instead of just taking today’s assets under management and multiplying that by a prorated amount of the 0.75% annual fee, it actually creates a shadow-NAV (net asset value) to apply the fee as well, based on the average index performance since inception, without giving you credit for fees already paid.

This is a terrible idea, and bad for investors (and hat tip to Sam Lee from Morningstar for writing about it extensively some years ago), and is one of the reasons OIL’s NAV is down 53%, when the index it tracks is down 45%—an unpleasant 8% surprise for anyone holding it.

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