Exchange-traded commodities funds have a future, says exec

Exchange-traded commodities funds will evolve and prosper, despite having drawn the attention of regulators concerned that they may have helped fuel a run-up in oil and natural-gas prices, according to a panelist at the InvestmentNews ETF Insights virtual conference last week. Providers of such products will look to “optimize” the underlying basket of securities in such funds — primarily futures contracts — to try to eliminate issues such as contango, when the price of a commodity for future delivery exceeds the spot price, John Hyland, chief investment officer at United States Commodity Funds LLC, said during a panel discussion on the future of exchange-traded funds. Other topics at the online conference, which was attended by 2,775 advisers, included what lies ahead for leveraged and inverse ETFs, and actively managed ETFs. But it was Mr. Hyland's comments that generated much of the buzz.

Speculation concerns

Exchange-traded commodities funds are currently under a cloud because of allegations that trading in the products fueled excessive speculation in futures markets during the run-up in oil and natural-gas prices in 2007-2008. The Commodity Futures Trading Commission has been investigating the transactions and could still put limits on holding futures contracts, making it difficult for such funds to operate, Mr. Hyland said. But the fever for regulation has cooled, he said, because it appears that the CFTC has looked at the data and is leaning toward the conclusion that exchange-traded commodities weren't to blame for the run up in oil and gas prices. Officials at the CFTC did not return calls for confirmation. If the CFTC has indeed concluded that exchange-traded commodities weren't to blame, that's the right decision, said conference attendee Bill Koehler, chief investment officer of ETF Portfolio Solutions Inc. “I think the regulators, like investors, are on a learning curve,” said Mr. Koehler, whose firm manages $52 million. The CFTC was right to be concerned initially but should now stand back, he said. Mr. Koehler still is undecided about optimizing exchange-traded commodities funds to eliminate issues such as contango. Increased optimization would require exchange-traded commodities to become “more active,” Mr. Hyland said. That's not necessarily a good thing, Mr. Koehler said. “We like ETFs because they are baskets of realities — they are what they are,” he said. “Backwardation [the opposite of contango], or contango, exist. That is a reality of the markets.” That doesn't mean he would be opposed to more-aggressive optimization. “I'd have to study it more,”Mr. Koehler said. Exchange-traded commodities funds, however, weren't the only product to come under scrutiny this year. In June, the Financial Industry Regulatory Authority Inc. released a statement in which it told broker-dealers that inverse and leveraged ETFs “typically are unsuitable for retail investors” who hold them longer than a day. Finra clarified its position on such ETFs in a July podcast in which it said member firms could recommend that a retail investor hold them for longer than one day, provided a suitability assessment is conducted with respect to such an investor and the ETF. But that didn't stop a number of broker-dealers from reacting to Finra's initial statement by restricting the sale of leveraged and inverse ETFs or stopping their sale altogether. Leveraged and inverse ETFs, however, are now much better understood, said conference panelist Dan O'Neil, chief investment officer at Direxion Funds. They are intended primarily for “tactical managers” who trade frequently, he said. A look at how rapidly such ETFs are traded shows that they are being used chiefly by such managers, Mr. O'Neil said. It bodes well for leveraged and inverse ETFs heading into 2010, because as trading costs continue to decline, financial advisers are becoming more tactical, he said. That may be true, but just because leveraged and inverse ETFs are being traded frequently doesn't mean everyone trading such products is a professional, said panelist Scott Burns, director of ETF analysis at Morningstar Inc. Investors who don't understand the risk of using leveraged and inverse ETFs can do real damage to their portfolios, he said. While leveraged and inverse ETFs made headlines this year, however, some panelists predicted that 2010 could finally be the year in which actively managed ETFs grab the spotlight. Invesco PowerShares Capital Management LLC launched the first equity-oriented actively managed ETFs in April 2008. Such funds have yet to catch on with investors. For example, Invesco PowerShares' five actively managed ETFs have just over $29 million in combined assets. It's just a matter of time, however, before such products catch on, said Bruce Bond, founder and chief executive of the firm. That's because most, if not all, of the benefits of a passive ETF — transparency, low cost and tax efficiency — continue to exist in an active ETF, he said.

Transparency an issue

The issue of transparency, however, is a stumbling block, said panelist George U. “Gus” Sauter, chief investment officer at The Vanguard Group Inc. The SEC continues to insist that ETFs provide investors with transparency equal to that of stocks. Most active portfolio managers, however, aren't comfortable about divulging their portfolios on a daily basis for fear they may be copied or that arbitrageurs may try to jump in front of their trades. There is a place for actively managed ETFs, Mr. Sauter said. But in the rush to develop such ETFs, it seems, providers are trying to “shoehorn” in strategies that may not be appropriate in an ETF structure, he said. It's “not the direction” in which the ETF industry should be headed, said conference panelist Rudy Aguilera, a founding principal of Helios LLC, an advisory firm with more than $60 million under management. E-mail David Hoffman at dhoffman@investmentnews.com.