Oil ETF Filed, But Will The SEC Bite?

May 19, 2005

ETF-newcomer Ameristock hits a potential gusher by filing for the world’s first oil-linked ETF. The question is: Will it pass SEC muster?

An application for the world's first oil-linked exchange-traded fund (ETF) was filed at the Securities and Exchange Commission (SEC) earlier this week, laying the groundwork for one of the eventual launch of one most anticipated ETFs in history.

In a huge surprise, however, the filing company was not one of the leaders of the ETF industry, but a new offshoot of Ameristock, a tiny mutual fund company based out of Alameda, California.  Ameristock currently manages a single mutual fund, the Ameristock Mutual Fund (AMSTX), a large cap value fund with assets of $1.46 billion; they have never managed an ETF.

The new fund - called the New York Oil ETF - will invest primarily in futures contracts on light, sweet crude oil trading on the New York Mercantile Exchange (NYMEX).  The fund should, within a margin of error, track the price of a barrel of crude oil.

It unclear when - or if - the SEC will approve the fund.  The closet comparable filing was for the streetTracks Gold ETF, the world's first commodity ETF; that application took more than a year to wind through the system.  In many ways, the oil filing is more complicated because it deals in futures contracts, whereas the gold ETF is designed to hold the physical metal as its sole asset.  The SEC has yet to approve the use of derivatives contracts in ETFs.

If the SEC does approve the fund, however, it will open the floodgates for a wealth of new possibilities for the ETF industry.

"Having ETFs that can be based on other derivatives is really one of the holy grails of the business," said Jim Wiandt, editor-in-chief of the Journal of Indexes.  "If you can do that, you can do almost anything...from any commodities to, say, macro futures equities on, say a local housing market, interest rates, currency combinations, etc."

But first things first…

There are many challenges that must be overcome before this ETF can be a hit.  Beyond the SEC review, for instance, there's the fact that NYMEX currently has a position limit on oil futures for a single investor of 20,000 contracts.  With an average notional value of about $50,000 (1000 barrels of oil X $50/barrel), the ETF can only own about $1 billion of oil future contracts at the NYMEX.  The fund gets some leeway in its prospectus to purchase options on futures and to engage in direct contracts outside of the exchange with other market participants (swaps, spot contracts, etc.), but these positions are less liquid than the broad futures market, which could present a challenge above the $1 billion mark.

And chances are good that the fund would top the $1 billion mark shortly after it's launched.  Individuals and institutions alike have long hungered for an easy and efficient way to gain exposure to oil, the most important commodity in the world.  The biggest use of the fund will likely be for hedging purposes, as oil has historically had a strong negative correlation with asset prices. Because it's an ETF and not a traditional mutual fund, investors would be able go short shares in the fund to protect their portfolios against the negative economic impacts of a rise in the price of oil.  In addition, companies would be able to use the ETF to efficiently hedge their own oil exposure - think small businesses, factories, airlines … even oil companies, in theory.

The Ameristock offshoot managing the ETF - which goes by the cute name "Standard Asset Management," harkening back to the old Standard Oil - has created an unusual two-tier fee structure for the new ETF.  For the first $1 billion invested, the fund will charge 40 basis points; after $1 billion, the expense ratio will drop to just 20 basis points.  This build-in two-tier system would be unique among U.S. ETFs.


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