Stand-Up Guy Vs. Fall-Guy

August 14, 2009

John Hyland's refusal to play regulatory roulette with UNG amounts to an immediate $1 million ding. Is it the right call for investors?


Most ETF wonks are probably peeling the glaze off their eyeballs when they see “UNG” in a headline. But they shouldn’t be.

The most interesting part of the whole affair with the United States Natural Gas ETF (NYSEArca: UNG) isn’t the details, although they’re worth repeating. The most interesting part is how U.S. Commodities Funds has chosen to react.

The details have been covered here a dozen times, and I blogged about it this time last month as well. In a nutshell, the SEC held up the fund’s routine request to issue new shares coincident with CFTC’s announcement that it was looking at putting position limits on energy commodities.

The upshot, as Murray Coleman reported yesterday, is that the fund traded at a monster premium—8.43% at yesterday’s close.

While I’m a total finance wonk, and I find the whole world of derivatives and commodities and ETFs and such fascinating, what I’m most impressed with here isn’t the fancy footwork, it’s the stand-up nature of USCF’s communications strategy.

But first let's consider how ETFs are sold, or perhaps more importantly, how they’re not.

ETFs, unlike insurance and some mutual funds, aren’t aggressively sold. USCF doesn’t have 100 wholesalers on staff offering up trips to
and 5% front-end loads for whatever broker pushes the most product. Instead, ETFs are largely field-of-dreams products. An issuer comes up with an idea, presumably thinks it’s a good one, puts together a team (including, critically, a few authorized participants who can help get the thing seeded) and puts it on the market. The issuer puts together a few fact sheets, a simple Web site, maybe takes out some ads, runs a webinar—but for the most part, ETFs are bought, not sold, and so the marketing process is educational.

Off The Beaten Path

This is a good thing. ETFs are all about transparency, and in general, the products literally speak for themselves. Investors and advisers look at what’s inside an ETF, and if they like it, they buy it. Where things get hinky is when the ETF is buying things that are a bit off the beaten path. This has been the case with the leveraged and inverse funds, and it’s also the case with futures-based commodities funds—like UNG and that other headline grabber, the United States Oil Fund (NYSE Arca: USO).

Both of these funds do exactly what they are supposed to do: They mimic the pattern of returns of owning a front-month contract, with timing and restrictions clearly outlined in the prospectus.

This was what John Hyland, the CIO of USCF, said at length in his extraordinarily well-constructed argument before the CFTC, which we carried here in full.

That Hyland eloquently and rigorously defended his company’s products isn’t a surprise. This is, after all, an industry full of very smart, articulate people.

What was surprising was his comment to the Wall Street Journal that while the SEC had in fact granted them an additional billion shares of potential creation—theoretically allowing the fund to grow to 4 times its current size—USCF would choose not to issue new shares at this time.

This is, to be blunt, a gutsy call.

With the gloves off and an 8% premium on, I have little doubt that UNG could have been $100 million larger essentially overnight. With the rather high expense ratio of 0.97%, Mr. Hyland has made a $1 million judgment call.

It’s also the right call, and one he won’t be given enough credit for.

In a world where the CFTC immediately imposes a position limit, UNG could face one of several outcomes. Existing contracts might be grandfathered, putting UNG in essentially the closed-end-fund situation it’s been in for a month. But it might also be required to liquidate its position over some arbitrary amount, forcing the fund to negotiate swaps in a hurry, or distribute cash out to its shareholders. Such an “emergency” distribution would be unprecedented, and likely a product killer.

It would be bad for investors, and terrible for USCF.

Better to be the stand-up guy now than the fall-guy later. Bravo, Mr. Hyland.

P.S. I've heard a few rumblings that this whole situation is a disservice to investors: that UNG has been transformed into a closed-end fund and that the very concept of single commodity ETFs may be in jeopardy.

My response: ETF premiums are just as transparent as ETF holdings; you can see the darn thing’s indicative NAV in real time just by looking on Yahoo, for pete’s sake. If you already own the shares, congratulations; you’re in the catbird's seat. If you’re buying in now, you know you’re facing that headwind. Caveat emptor.

Dave Nadig is director of research for Index Publications LLC, the parent of He welcomes comments and suggestions for future columns at: [email protected].


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