Investing In Energy Vs Speculating In Oil

March 24, 2015

Future-Linked Oil ETFs

Apart from USL, alternatives for those who expect a WTI rally and wish to bet on it include the United States Oil Fund (USO | B-100).

 

Both aim to track the WTI through investing in oil-related futures contracts. The primary difference between the two is that USO uses the near-month futures, while USL equal-weights each of the next 12 months.

 

A big challenge for futures-based ETFs is that oil futures contracts expire monthly, so new contracts must be purchased to replace them. This “roll” can dampen portfolio returns due to transaction costs and the fact that replacement contracts for the next term are available at higher prices in an upward-sloping yield environment—a condition called “contango.”

 

Charting Returns

We compare the price of spot WTI with the ETFs VDE, USO and USL since 2007 in the following chart based on data from Bloomberg. Our client accounts currently hold VDE, but do not hold the other ETFs. 

 

 

Source: Bloomberg

 

VDE shows the virtues of diversification and is the only one that’s even close to breakeven over the time period shown. USO has lagged significantly due to the roll impact I discussed above. USL’s smoothing of the futures results in less roll impact, but it has still lagged WTI.

 

With VDE partly insulated from the sharp WTI price decline, it certainly appears the better bet for longer-term investors. However, VDE also insulates investors from sharp WTI price increases.

 

One interpretation may be that using an ETF that invests in company securities is better for long-term buy/hold investors but ETFs that use futures may be better for short-term speculators.


At the time this article was written, the author’s firm held shares of VDE in client accounts. ValMark Advisers Inc. is the manager of the TOPS Portfolios of ETFs. ValMark started managing "TOPS" separately managed accounts of ETFs in 2002. The firm manages more than $5.1 billion in ETFs for retail and institutional clients in multiple investment products. Email:[email protected]. Phone: 800-765-5201. For a complete list of relevant disclosures, please here.

 

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