Commodity ETF Performance Lags Underlying Futures

The poor performance of commodity exchange-based funds relative to underlying crude oil and natural gas prices over recent years stems from inherent inflexibility of ETFs, suggesting investors may be better off going directly to futures markets, according to a study by CME Group directors Richard Co and John Labuszewski.

One popular ETF, the United States Oil Fund LP, underperformed spot crude prices by nearly 200% from December 2008 through April 2011, a period when the market rallied while maintaining a "contango" pattern. The United States Natural Gas Fund ETF also lagged the spot market during that period.

Such ETFs "are generally unable to replicate the performance of the benchmark spot commodity values," Co and Labuszewski wrote. That primarily reflects requirements that these ETFs can’t hold physical inventory, must maintain 100% collateralization with no leverage and must maintain a fixed rollover strategy, regardless of the shape of the forward futures curve.

"The investment and administrative policies of some of the major commodity ETFs contribute to their inability to replicate the performance of the commodities that they purport to represent," they said. "These shortcomings may be addressed by introducing a certain degree of flexibility in the management strategy (and) by relaxing restrictions on collateralization and rollover strategy."

Astute investors, they added, should consider "whether the option of direct investment in futures should be considered as an alternative to investment in an ETF."

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