[click to enlarge]
The spot West Texas Intermediate Crude price change was more favorable than the change for the Goldman Sachs Oil Total Return Index (which also includes interest from Treasuries that would be held as collateral in the futures account). In the 1-year chart above , the final values (as of April 20th) relative to their base of 100 at the beginning of the year were 86 for spot oil and 69 for the oil index.
So, we begin our trial knowing that the unmanaged futures index declined 31% and unmanaged spot prices declined 11% over the last 12 months. The futures index was 20 points behind.
The Plaintiffs:
For the past few weeks, some financial writers have been asserting that the funds have under-performed their benchmarks badly. The most recent of several examples was the April 19 Wall Street Journal article (a Dow Jones publication) subtitled "ETFs, Which Are Meant To Track Benchmarks, Increasingly Go Astray". It said:
.. some ETFs have begun diverging widely from the performance of the benchmarks they are supposed to follow ... Victoria Bay Asset Management's U.S. Oil Fund, one of the fastest-growing ETFs of the past year, has fallen more than 15 percentage points behind the oil price it was designed to track. … That kind of divergence can hurt shareholder returns.
The Defendant: (USO), an ETF by Victoria Bay Asset Management
Implicated But Not Charged: (DBO), an ETF by Deutsche Bank
(OIL), an ETN by Barclays Global Investors.
Evidence Against the Defendant:
Q: What is USO supposed to track?
A: The spot price of WTI crude. The disclosure statement on their website says,
The investment objective of USO is for the units’ net asset value [NAV] to reflect the performance of the spot price of West Texas Intermediate light, sweet crude oil delivered to Cushing, Oklahoma (“WTI light, sweet crude oil”), less USO’s expenses.
Witnesses for the Defense:
April 23, Market Watch (also of Dow Jones) wrote that concerns about tracking errors by oil ETFs are misplaced. It said,
... industry insiders claim the comparison isn't appropriate. The spot price investors typically see in the news is quoted for immediate delivery, they note, while the ETF invests in futures and continually 'rolls' the contract to maintain exposure to oil. In other words, the product's structure is sound and the problem stems from misunderstandings about how futures markets work
Testimony by the Defendants and the Implicated:
They were either were unwilling to testify; or they were a bit technical with contango-fandango market conditions, backward something or other and “negative roll yields” -- please give me an aspirin.
It’s all very interesting and true – if you are a geek or worse yet a futures trader – but we don’t have to go there to settle this case (maybe we’ll talk about “contango” and “backwardation” in another article)
Expert Testimony by QVM Group:
The problem is that USO and other funds that track crude oil, don’t own spot oil. They either own oil futures, as does USO and DBO, or they promise to adjust debt obligations based on an oil futures index, as does OIL. As our chart (shown above) clearly indicates, the unmanaged futures index under-performed the raw spot price. There are reasons for that which could be debated, but the fact is the index under-performed spot prices
Decision of the Judge:
USO -- guilty as charged with respect to results being well below published benchmark.
USO clearly set the spot price as the benchmark. They knew that they could not actually own the physical oil in the portfolio and clearly stated in their disclosure documents that they would use futures contracts to pursue their objective. They either bet wrong or they should have set a futures index as their benchmark.
Potential penalty – naughty, naughty, naughty!
Implicated funds are cleared of all guilt by association.
OIL has a contractual obligation to be on target with its futures index benchmark and has intraday and weekly arbitrage features to cause the market price of the shares to remain close to NAV during the term of the debt.
DBO -- well they can’t deviate much from their objective results. Their proprietary benchmark defines their process. One is the other.
Final Penalty: This court has decided to have mercy on USO as a first time offender, but notes that this court has a two strikes and you’re out policy. USO did carefully point out in their prospectus that there is no guarantee that the objective would be achieved – boy were they right in that.
USO, OIL and DBO have had similar results recently. The three took turns being on top at points during the last 3 months (see share price chart below).
This court remands USO to self-custody to fix the problem. That means they need to either change their benchmark to a futures index that resembles what they do, or admit that they really blew it trying to better the performance of the spot price of oil with futures techniques.
USO, OIL, DBO 1-yr chart:
Disclosure: Author does not own any securities named.
