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The Weekly Walk of Shame: Oil ETFs

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Motley Fool General Manager Randy Coon stopped by my desk last week and asked me what I was buying. After an extended answer that wasn't terribly intelligent, I replied in kind, and asked my boss's boss's boss what he was up to. He said:

"Not a whole lot, other than getting completely screwed by the USO."

More than one year ago, Randy looked at $40 oil and called its bluff. Rather than building a 50,000-gallon storage depot in his backyard (which, in retrospect, might have been a better idea), Randy instead chose to make an investment in an oil ETF that implicitly promised to track oil prices.

The problem is that Randy has gotten completely screwed. While oil roughly doubled in the ensuing months, Randy is up just a few measly percentage points on his investment in the United States Oil Fund (NYSE: USO  ) -- a truly disgraceful performance. The interesting part is that this problem is not reserved to this one lousy fund. In fact, the problem spans the entire industry of oil ETFs. The problem is this week's Walk of Shame.

A failure to deliver
As much as I like to rip on Wall Street, financiers tend to do a pretty good job of giving you exactly what you ask for -- if only on an extremely literal level. At Goldman Sachs (NYSE: GS  ) , for example, if you ask for a mortgage security that yields 8%, the company will find one for you. The firm might neglect to mention that it's a terrible piece of crap. But, if all you asked for was big yield, then Goldman has technically fulfilled its end of the deal -- at least, so it says.

In this case, however, investors think they have asked for something relatively unambiguous (to track the price of oil), yet the companies that marketed these supposedly straightforward services have very clearly not held up their end of the bargain. They've failed on one of two levels, or perhaps on both. They failed to properly communicate that these ETFs are not, in fact, designed to track oil, or they failed to mention that they actually can't track oil on any kind of consistent basis. Either way, they've failed. Just examine the numbers.

Extraordinary underperformance
I've taken a close look at the performance of two ETFs and one ETN that are all implicitly designed to mirror the performance of oil. They include the U.S. Oil Fund, the PowerShares DB Oil Fund (NYSE: DBO  ) , and the iPath S&P GSCI Oil Total Return Index (NYSE: OIL  ) . I plotted out the relative returns of each of these entities against the performance of oil futures traded on the NYMEX (WTI), and I paid specific attention to the time period since oil crashed in December 2008. Here's what I found:

The graph is telling. As you can see, oil (found in blue) has indeed spiked since it bottomed out in early 2009. Randy was smart enough to know that it would. What he didn't expect, though, was that while real oil returned nearly 90%, his ETF would be up a pathetic 18%. As a matter of fact, all three funds have been grossly inadequate.

Shockingly, the only fund that comes closest is not actually an oil ETF at all. It's the SPDR S&P Oil & Gas Equipment & Services ETF (NYSE: XES  ) -- which I coincidentally bought. It includes big service players like Halliburton (NYSE: HAL  ) and others.

How much error is too much error?
Tracking error is a well-documented phenomenon playing a small role here. For a variety of reasons, ETFs, especially hard-asset ones, have difficulty keeping pace with their respective benchmarks -- which is fine. A point lost here or there is totally legitimate when it comes to emulating an index with no obvious way to mimic. This is probably why firms assign specific benchmarks that are not the precise closing price of oil, but rather something very close (the Goldman-Sachs Crude Oil Index, for example). But let's be reasonable about this. When you're off by almost an entire order of magnitude in performance, you might want to reassess your whole operation. Whatever these things are, they're clearly not effective plays on oil.

What about the money?
There's another fascinating part of this equation: the money. At the exact same time that these funds were lobbing up airballs against their implied benchmarks, the firms that ran these funds were collecting fees -- a lot of them. How much are we talking?



AUM (millions)

Total Annual Fees

US Oil Fund




PowerShares DB Oil




iPath S&P GSCI Oil Index




All data from Yahoo! Finance, except for the OIL ETN, which is from prospectus and assumes all notes are bought and held.

Should investors really be charged fees in the face for this kind of performance? I don't know. But I do know that if I asked my auto-mechanic to fix my tires and he replaced the steering column, I wouldn't give him the time of day.

If this were the real world, and not Wall Street, these firms would be making investors whole for the absolutely terrible performance of their products. At the minimum, they would return the management fees they've been collecting.

The Foolish bottom line
Perhaps this is just another case of Wall Street firms being exceptionally technical when it comes to the delivery of a product. We didn't say we were going to give you oil, per se; we said we'd give you an index that was meant to track oil. Sure. Or, perhaps, this is a case where companies have been, in fact, completely misleading about what they are really selling. Clearly, these are not 1:1 oil ETFs.

Either way, now you know. In the future, regardless of what you might see in advertisements, don't expect these ETFs to come remotely close to tracking the price of oil. Caveat Emptor.

Fool Nick Kapur owns shares of the SPDR Oil & Gas Equipment & Services ETF. He's glad he actually bought a real oil ETF. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.

Read/Post Comments (5) | Recommend This Article (22)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 30, 2010, at 7:57 PM, Slipswitch wrote:

    I got ripped off by this fraud too. What you didn't mention is how they calculate gains. Even though I lost on one transaction, USL and USO based gains on annual performance, so I had a gain for tax purposes. Maybe they got lessons in accounting from Madoff.

  • Report this Comment On June 30, 2010, at 8:10 PM, TMFAleph1 wrote:


    I think you're being unfairly harsh on the ETF provider in this instance.

    The problem is that USO takes long positions in oil futures. Investors who own USO should be familiar with the concept of 'roll yield', which is at the basis of the underperformance you refer to.

    (This risk is not restricted to oil ETFs, it applies to any ETFs that use futures to track a commodity/ asset.)

    The fact that USO is based on the crude oil futures contract is made clear on the front page of the ETF's website and is described in some detail in the prospectus. If an investor doesn't understand or isn't aware of how futures work, he/ she shouldn't buy the ETF.

    Alex D

    Alex D

  • Report this Comment On June 30, 2010, at 9:17 PM, TMFAleph1 wrote:


    I think the notion of 'implied goal' is difficult to pin down here. I think where we differ here is who is responsible for sorting out the difference between what one is setting out to achieve (short-term or long-term investment, for example) and what one should expect to achieve given the mechanics of the product.

    To put this in more concrete terms: Over short timeframes, USO tracks spot oil closely; the problem arises over longer time periods. Many ETFs are designed for short-term traders, rather than long-term investors.

    Different market participants have different goals. My position is that it is ultimately each investor's responsibility to figure out whether the product is well-suited to achieving their specific goal.



  • Report this Comment On June 30, 2010, at 10:53 PM, MNaggie wrote:

    ALL commodity ETF's performance suffers from contango. I get my head taken off on every Fool board I've written this (see MF Pro US Nat Gas ETF), but it is simple arithmetic. The ONLY way to track the physical commodities SPOT price, is to own the physical commodity and pay the "carry cost", which is reflected in contango. Talk to your industry contacts in the oil and gas marketing companies you follow. They will tell you this as well. The carry cost is reflected in the nymex futures every time in a flat or bearish market the nearby futures long approaches expiration and must be "rolled" to the next contract. The nearby futures are sold at a discount to the next futures month, and this discount is eaten by the ETF investors on TOP of the fees charged inside the fund. This is a very well known phenomena in commercial commodity merchandising circles (those of us who "carry" physical commodities (ag commodities in my case) known as the "Goldman Roll"). do you suppose it got that name? As a carrier of the physical, I will wait for the Goldman Roll, and roll my short futures hedge (versus the physical) at the widest possible "carry" or "contango". This more than offsets my carry (storage and interest and shrink) cost. This is Hedging 101, and has been around since the founding of the Chicago Board of Trade in the late 1800's. The commodity ETF's are a sucker's bet, due to the drag from rolling a long nearby futures position into contango. In a bull market, the neaby futures lead the market higher, resulting in "backwardation". In this case, the ETF may actually outperform due the selling nearby futures at a premium to the next month during the "Goldman Roll" period. This is not new, it's been around for a century. I was thrown under the bus somewhat on the Pro boards for pointing this out. I'd advise the Fool advisors get this concept figured out prior to recommending commodity ETF's. In fact, in the US Nat Gas prospectus, the drag on returns from contango is disclosed.

    Love the Fool service, but this sets my teeth on edge.

  • Report this Comment On July 13, 2010, at 2:18 PM, msimpson2 wrote:

    kuhlou00 post above nailed it.

    “The commodity ETF's are a sucker's bet, due to the drag from rolling a long nearby futures position into contango.”

    I’ve been saying this about USO for over a year too. Holding an oil ETF like USO is not unlike being long a call option. The carry cost is like a time premium, constantly working against you and eventually eroding to nothing.

    Further complicating things, commodity ETF’s tend to be a black box when it comes to specific investments they hold. I wonder how many of their holdings are OTC derivative contracts, which as we all know are more susceptible to off-market pricing, third-party kickbacks, etc. I suspect there is more investor money getting siphoned off in the form of commissions, fees, trading margins and other expenses then meets the eye.

    These oil ETF’s may be O.K. for a short-term gamble (no better than a futures position though), but, they are a lousy vehicle for a long term investment in oil. I’ll take BP at $33 over USO for that. Just did last week.

    USO is truly a fools bet.

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