Given the recent and unprecedented volatility in crude oil prices, we thought this would be an opportune time to take a deeper dive into how some popular oil and oil-related funds have performed this year. Oil had a spectacular collapse in 2020, with April’s intra-month decline demonstrating its worst in the history of traded petroleum products. Just before its futures contract expiration, crude oil traded into negative territory, falling to a low of -$37. Once it broke below the zero threshold, the speed was inconceivable, as traders were willing to pay anyone to take oil contracts off their hands, struggling to avoid delivery, as storage was unavailable.
Funds that seek to replicate or incorporate the commodity’s price movement must invariably use futures or futures derivative contracts. However, futures contracts pose their own set of challenges for a fund because the contracts must be “rolled over” periodically (usually monthly), and this introduces additional costs for the portfolio and a drag on performance.
The results of our research show that many funds experienced larger drawdowns in comparison to the continuous oil contract price. Oil-related funds failed to track the price trajectory of oil, with some funds hitting lows before oil, while others kept declining even after oil had already rebounded. Even more significantly, funds have continued to underperform after the rebound from its April lows (bolded line in the second chart below). A sample of funds are below.
|WTIC – Continuous contract price of crude oil|
|USO – United Stated Oil Fund|
|OILNF – iPath® S&P GSCI® Crude Oil Total Return Index ETN|
|UCO – ProShares Ultra Bloomberg Crude Oil (uses leverage)|
|DIG – ProShares Ultra Oil & Gas (uses leverage)|
An aspect of this data to highlight is that trying to mimic the price of oil within a traded product is difficult. Take April results for example. From March’s closing price to April’s close, the difference was only -6%, if looking at the continuous price contract. However, if actually trading oil, there was a futures contract that expired in April, and if intending to hold a long-term position, one would have had to trade out of that contract, into a further-dated contract. The fund managers that complete the rolls of the contracts have factors at play including which day (or days) to roll the contracts, rapid-moving prices, and liquidity. They had to contend with prices in April having numerous intraday price swings of over 30%. This makes things difficult if trying to track a benchmark that chooses one day of the month to start using the next contract. A continuous contract price chart is not contending with liquidity or the daily factors affecting price movements. The results show that as prices both declined and advanced, the traded products were unable to mimic the continuous contract prices.
Below shows a graph of traded oil related products and their performance January 2 – June 5, 2020.
Mutual Fund returns and commodity-related products suffered as well. However, with some having more diversification outside of just the oil or energy space, the depths seen in more diversified funds were usually tapered. Some funds held up much better than others. Quite a few oil-related funds did not make it through the turmoil, resulting in some having reverse splits, while others were delisted completely.
It boils down to this: if trying to track a product, commodity, index or any other asset, research to determine if it indeed is designed to perform as you think it should in a myriad of market environments, or are there factors that will hinder its performance when you need it to perform as expected.
We are currently adding the finishing touches on a white paper that dives deeper into this very important topic of diversification. Diversification and risk management directly impact portfolio returns and the investment experience. Especially in today’s environment, a simple equity/fixed income split may have difficulty to perform as well as a portfolio that is truly better diversified, and knowing if your diversifier is truly diversifying is more important than ever. Stay tuned.
Rui Matos, CFA, CFP, FRM contributed to this article. Disclosure: Author holds both long and short oil positions.