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An ETF for a Wild Oil Market · Trillions

• 0:02
  Speaker 1: Bloomberg Audio Studios. Podcasts. Radio. News.
• 0:09
  Speaker 2: That's the thing that I find a little bit jarring.
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  Speaker 2: So when you hear absolute, you think of a positive number.
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  Speaker 2: You basically think of something going up. It's saying I'm
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  Speaker 2: giving you a return whether the markets are going up
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  Speaker 2: or down because of my ability to go long or short.
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  Speaker 1: Welcome to Giants. I'm Joel Weber.
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  Speaker 3: And I'm Eric Balchunas.
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  Speaker 1: It's hard not to talk about oil this year. It's
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  Speaker 1: just been a theme. But I was surprised for this
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  Speaker 1: episode to learn about an ETF other than the United
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  Speaker 1: States Oil Fund, USO, which is just the big dog
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  Speaker 1: in oil. And it's the one that we usually talk
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  Speaker 1: about when we talk about oil. But this other ETF
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  Speaker 1: is pretty dynamic, same flows. And it has some aspects
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  Speaker 1: that normal investors might want to know about. And I
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  Speaker 1: can say this for the first time ever, you could
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  Speaker 1: actually like maybe think about being a retail investor who
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  Speaker 1: touches oil. It still holds futures, which is just the
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  Speaker 1: nature of a commodity ETF. But you won't get a
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  Speaker 1: surprise from tax season either. This time on Trillions, a
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  Speaker 1: new oil trade. Every time we talk about oil, we
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  Speaker 1: talk about a certain ETF, which is the United States
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  Speaker 1: Oil Fund. The ticker for that is USO. And your
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  Speaker 1: research has surfaced a new one. Which is it?
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  Speaker 3: Yeah, right. So USO is the famous one. It holds
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  Speaker 3: futures very close to what we call front month. So
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  Speaker 3: it's very sensitive, but has some other issues which we'll discuss.
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  Speaker 3: But it's by far the most popular. But there's another
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  Speaker 3: one that is just maybe a little more risk averse
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  Speaker 3: and a little safer for people than USO called USE,
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  Speaker 3: which is U-S-E. which is the word for I want
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  Speaker 3: to use something, or the plural word for you in Philly,
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  Speaker 3: use guys. Sorry, bad joke. Local joke. It's true, though.
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  Speaker 3: I hear use once a week here. Anyway, the USCF
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  Speaker 3: Energy Commodity Strategy Absolute Return Fund. So we'll go in
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  Speaker 3: what it is. But just real quick, Joel, I find
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  Speaker 3: this oil trade fascinating because it just seems like Trump
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  Speaker 3: is caught in between these two opposing forces. And that's
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  Speaker 3: why this oil trade has been so fun for traders
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  Speaker 3: because Iran does something to irk him and he goes
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  Speaker 3: wild with the tough talk. And then oil spikes because like, oh,
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  Speaker 3: they're going to close the straits. Then stocks go down
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  Speaker 3: because oil spiking and inflation fears ramp up. And he's like, oh, no,
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  Speaker 3: because he loves the stock market being up. So he's like, oh,
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  Speaker 3: we have a deal or we may have a deal.
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  Speaker 1: Yeah, I've heard that a few times.
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  Speaker 3: And there's probably been like, I'm going to no lie.
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  Speaker 3: 20 stock market rallies based on hopes of a deal.
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  Speaker 3: It's like that Dave Chappelle meme, got any more hopes
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  Speaker 3: of a deal? Anyway, and once the stock market goes
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  Speaker 3: back up, he goes back to being upset about Iran
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  Speaker 3: and around and around we go. So we thought we'd
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  Speaker 3: focus on the oil side of this equation. And Andre
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  Speaker 3: picked a real hidden gem here.
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  Speaker 1: And Andre is Andre Yap. He's a ETF investor. Research
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  Speaker 1: Senior Associate at Bloomberg Intelligence. Andre, welcome back to Trillions.
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  Speaker 2: Thank you for having me.
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  Speaker 1: Okay, now remind our listeners how the ETF of the
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  Speaker 1: moment happens. You guys are constantly looking at ETFs, but
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  Speaker 1: this is a little different in that you have some
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  Speaker 1: screening mechanisms to see what's got some momentum.
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  Speaker 2: Yeah, so we take a quantitative approach to try to
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  Speaker 2: identify ETFs which are having a moment. Basically, we screen
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  Speaker 2: based on two criteria. We screen based on returns. The
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  Speaker 2: returns need to be positive, particularly over the short term
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  Speaker 2: to show that there's some momentum happening right now. And
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  Speaker 2: we also look to see an increase in trading volume.
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  Speaker 2: So we want to see typically at least a 50%
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  Speaker 2: jump in the number of shares that are being traded.
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  Speaker 2: for us to even consider it as a candidate for
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  Speaker 2: the ETF of the moment.
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  Speaker 1: And if all of those signals kind of work in
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  Speaker 1: its favor, what distinguishes an ETF of the moment?
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  Speaker 2: I think what distinguishes it, why we would probably pick
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  Speaker 2: amongst the peer group, is something that is topical, something
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  Speaker 2: that people want to hear about, something that we want
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  Speaker 2: to explore, and that seems interesting or fun or just weird.
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  Speaker 1: And usually... Because it's of the moment, it's like we're
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  Speaker 1: getting a little sneak peek of something that's going to
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  Speaker 1: be trending in the near future. So talk to us
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  Speaker 1: about USE, is the ticker, the USCF Energy Commodity Strategy
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  Speaker 1: Absolute Return Fund. That's a pretty long mouthful of a name.
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  Speaker 1: What does it do and how does it work?
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  Speaker 2: Yeah, it's an absolute mouthful. So it's an actively managed ETF.
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  Speaker 2: that utilizes long, short, or spread positions in futures contracts
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  Speaker 2: tied with energy commodities. By energy commodities, I don't mean
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  Speaker 2: simply crude. So it's tied to WTI and Brent crude,
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  Speaker 2: as well as natural gas, gasoline, diesel, and I think
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  Speaker 2: gas oil. So it spans the energy gamut. So that's
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  Speaker 2: how it differs a little bit from USO, the more
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  Speaker 2: popular brother.
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  Speaker 1: Okay. And speaking of which, we've talked about USO a lot.
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  Speaker 1: The thing that Eric always talks about with USO, the
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  Speaker 1: United States Oil Fund, we're rolling futures with that ETF,
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  Speaker 1: which instantly puts it in a world where retail investors
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  Speaker 1: in particular are potentially going to get punished. Does this
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  Speaker 1: still touch futures? And if so, how does the role
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  Speaker 1: differ from what USO does?
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  Speaker 2: Yeah, it still touches futures. So it's still buyer beware somewhat.
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  Speaker 2: It differs in that with USO, it basically only goes long.
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  Speaker 2: So you can get into a situation where you're basically
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  Speaker 2: facing the rolled yield, where you can basically get positive
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  Speaker 2: or negative returns, depending on whether the market's in contango
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  Speaker 2: or backwardation. The same risk exists with use. However, the
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  Speaker 2: strategy is more dynamic because it has the capacity to
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  Speaker 2: go long, to go short, as well as take spread positions.
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  Speaker 2: So it's a little bit more dynamic in its strategy
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  Speaker 2: and implementation of it. than USO, in my opinion.
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  Speaker 1: Why is that interesting, Eric?
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  Speaker 3: Yeah, because, I mean, just for anybody out there, think
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  Speaker 3: about the oil futures curve and words like contango. And
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  Speaker 3: that curve changes a lot based on what people think
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  Speaker 3: oil will be worth in the future. And it's a
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  Speaker 3: very specific local market that experts trade in. But if
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  Speaker 3: you're not one of those people, this is sort of
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  Speaker 3: like saying, hey, look, let's take this company that knows
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  Speaker 3: this market well and let them kind of trade around
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  Speaker 3: this and try to exploit the oil situation as best
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  Speaker 3: they can and really free them up to go short
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  Speaker 3: if they need to. And by doing long short, you
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  Speaker 3: also bring your volatility down a little, right? Because sometimes
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  Speaker 3: you have some offsetting positions. So this is a slightly
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  Speaker 3: less volatile ETF than USO. So in the downturns, when
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  Speaker 3: Trump was like, told everybody there's hopes of a deal
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  Speaker 3: and oil came crashing down, this one will come down
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  Speaker 3: a little less. But pound for pound, I just think
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  Speaker 3: it's an interesting option. It's still very small. The price
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  Speaker 3: is still at 79 basis points. It only has 7 million.
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  Speaker 3: So there are some things that I don't love about it.
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  Speaker 3: But I think there are just some areas of the
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  Speaker 3: market where handing it over to an active manager who
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  Speaker 3: can just do things with no restraints can work well, potentially, again.
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  Speaker 3: So this is just an alternative to USO, which is
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  Speaker 3: much more of a, robotic ETF that's just giving you
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  Speaker 3: the front month futures for better or worse.
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  Speaker 1: So you actually have a human in the cockpit with this. Andre,
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  Speaker 1: what's the performance been like?
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  Speaker 2: Well, it's been somewhat of a mixed bag, but this
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  Speaker 2: year the performance has been pretty good. So if you're
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  Speaker 2: looking at it on a year-to-date basis, it's up 83%.
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  Speaker 2: But if you compare it to USO or just the
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  Speaker 2: WTI in general, WTI crude, those are up 100% 86%
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  Speaker 2: for USO and 153% year to date for WTI. So
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  Speaker 2: it does lag them a little bit. But if you
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  Speaker 2: look at it just over the third quarter, which is
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  Speaker 2: basically from July till right now, we're not completely through.
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  Speaker 2: It's pretty much in line. They're all up about 35%.
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  Speaker 3: Yeah, I mean, 50% return year to date is still
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  Speaker 3: pretty good. Although USO is up 100%. But this is,
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  Speaker 3: by the way, I just got to say one thing, USO,
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  Speaker 3: The people trading this thing have done a good job
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  Speaker 3: of taking profits. So there's been a lot of flows
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  Speaker 3: in and out of USO, and people generally think it
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  Speaker 3: just loses money for people, but it's actually been traded
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  Speaker 3: pretty effectively. When it goes up, people pull the money out,
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  Speaker 3: and then when it goes down, they put it in.
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  Speaker 3: I think the trading crowd is really on to this
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  Speaker 3: sort of like– what would you call it? Loop or
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  Speaker 3: cycle that Trump is involved in with getting mad at
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  Speaker 3: Iran and then like trying to do a deal, and
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  Speaker 3: it's becoming pretty profitable trade.
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  Speaker 1: Back to to use for a second use what does
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  Speaker 1: absolute return mean since that's actually part of the name right.
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  Speaker 2: That's the thing that i find a little bit jarring
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  Speaker 2: so when you hear absolute you think of a positive
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  Speaker 2: number you don't think of or you basically think of
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  Speaker 2: something going up um and i think what it implies
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  Speaker 2: or at least what i got from the name when
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  Speaker 2: it says absolute return it's saying i'm giving you a
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  Speaker 2: return whether the markets are going up or down because
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  Speaker 2: of my ability to go long or short and that's
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  Speaker 2: an implication but if you read through the actual prospect
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  Speaker 2: it doesn't make any claims to say that it actually
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  Speaker 2: does that where it's saying we'll generate positive return no
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  Speaker 2: matter what happens with the market so it's a little
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  Speaker 2: bit of a catch-all and what's funny So we did
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  Speaker 2: some analysis of users historical returns, and we basically tried
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  Speaker 2: to see how well they're tracking the market to generate
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  Speaker 2: positive returns, regardless of what the market is doing. In
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  Speaker 2: order to do that, we categorize the market into up
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  Speaker 2: regimes or down regimes. Up regimes being essentially periods where
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  Speaker 2: the 50 day moving average is above the benchmark. And
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  Speaker 2: that has been positive for at least the past five days.
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  Speaker 2: So we're not looking for spikes to somewhat deter or
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  Speaker 2: the dictates it is. We're looking for a smooth transition
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  Speaker 2: and down markets being essentially the opposite. And what we
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  Speaker 2: found is essentially uses return is just positive correlated regardless
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  Speaker 2: of the market regime. So when markets are up, use,
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  Speaker 2: it delivers positive return. When markets are down, it delivers
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  Speaker 2: the same returns. It delivers negative returns. So it moves
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  Speaker 2: in line with the market, which is to say it
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  Speaker 2: is positively correlated. So the absolute return might be a
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  Speaker 2: little bit of a stretch.
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  Speaker 1: Yeah, I agree.
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  Speaker 3: I think when you see absolute return, I kind of
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  Speaker 3: think hedge fundish. It's not tracking a benchmark, you know,
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  Speaker 3: like a regular active mutual fund will be like benchmark
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  Speaker 3: to the S & P. That's not absolute return. That's
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  Speaker 3: trying to get return over the benchmark. This is just saying, hey,
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  Speaker 3: we can kind of try to get return in any environment.
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  Speaker 3: But to Andre's point, that is one ding on this
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  Speaker 3: fund is that you would think I would like to
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  Speaker 3: see more buffer in the downturn. I would like to
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  Speaker 3: see it go short a little more. when the market's
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  Speaker 3: going down, and like you said, overall volatility coming down
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  Speaker 3: and be a little more like a hedge fund. But
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  Speaker 3: to Andre's point, it just seems like it has a
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  Speaker 3: lot of beta to oil, more than you would expect
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  Speaker 3: with the name absolute return. And that's an important point here.
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  Speaker 3: But again, it is the active manager's choice. Maybe they
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  Speaker 3: are just thinking that's what you need to do at
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  Speaker 3: this time. But we'll see. It's also just good to
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  Speaker 3: highlight that when you go into an ETF category, and
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  Speaker 3: there's the famous one, like USO is probably like you know,
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  Speaker 3: the majority lion's share of the assets. There are, you know,
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  Speaker 3: multiple choices of ways to do this. There's another one
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  Speaker 3: called UNL that holds all of the months at once.
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  Speaker 3: And that's just like owning the whole curve. And that
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  Speaker 3: would be also another option for somebody who wants a
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  Speaker 3: sort of kinder, gentler oil play. They're all red light
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  Speaker 3: products because oil futures is a really exotic, wild category.
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  Speaker 3: And the way they roll can cause unhidden costs and Yeah,
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  Speaker 3: just be very careful. This is very like a lot
• 12:43
  Speaker 3: of trap doors and snares. That's the case for active,
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  Speaker 3: but still, even with that knowledge, it's hard.
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  Speaker 1: So that red light mention is actually a Bloomberg Intelligence
• 12:53
  Speaker 1: classification system, and it's not really meant to be a judgment.
• 12:56
  Speaker 1: It's just if you're going to use these products, red
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  Speaker 1: light means there's going to be some technical aspects of
• 13:05
  Speaker 1: the products that you should know about.
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  Speaker 3: Yeah, anything that rolls futures, whether it's VIX futures or
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  Speaker 3: natural gas or oil is an instant red light because
• 13:14
  Speaker 3: it's just so on. It's an unusual thing. Normal people
• 13:18
  Speaker 3: don't really think about it or know about it. Like
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  Speaker 3: if I said the word contango to any of my
• 13:22
  Speaker 3: friends or family, they would think I'm talking about a dance. Yeah.
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  Speaker 3: But contango is when you roll futures and everyone's more expensive.
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  Speaker 3: So you pay a little, let me give one quick
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  Speaker 3: thing here. This is, this helps people crystallize why futures
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  Speaker 3: are so brutal. Put it this way. When futures are expiring,
• 13:41
  Speaker 3: they're going to send oil to your house. And like
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  Speaker 3: nobody in their right mind wants oil sent to their
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  Speaker 3: house because it's toxic and you can't store it in
• 13:49
  Speaker 3: your backyard. So the more cumbersome the commodity is to store,
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  Speaker 3: like oil or corn, the more the market knows that
• 13:59
  Speaker 3: and it's going to price up the next month. So
• 14:01
  Speaker 3: for you, you want to get out before it expires
• 14:03
  Speaker 3: and you have to pay up. So in other words,
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  Speaker 3: the storage cost and pain in the assness is baked
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  Speaker 3: into the curve because they know you don't want to
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  Speaker 3: take delivery. So just think of how annoying the commodity is.
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  Speaker 3: And that's how much you're probably going to pay in
• 14:16
  Speaker 3: these roll costs. So that's why gold isn't that bad.
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  Speaker 3: Like the futures market's pretty chill because you could get
• 14:22
  Speaker 3: gold delivered to your house. It's no big deal. But oil, corn,
• 14:27
  Speaker 3: I mean, you know, I guess coffee would be OK.
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  Speaker 3: i guess the more the delivery is no big deal
• 14:32
  Speaker 3: the less the curve will hurt you but oil is
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  Speaker 3: like the worst you know nobody wants a barrel of
• 14:38
  Speaker 3: oil sent to their house.
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  Speaker 1: It's a great way to think about it that i
• 14:42
  Speaker 1: don't think you've ever said it that way before that
• 14:44
  Speaker 1: totally makes sense and i actually i don't want coffee
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  Speaker 1: sent to me because it'd be like a raw commodity
• 14:49
  Speaker 1: it's not like it's been roasted or anything it'd just
• 14:51
  Speaker 1: be like beans i don't need that uh So we've
• 14:55
  Speaker 1: talked a little bit about the potential downsides of use
• 14:57
  Speaker 1: and also just the space. One thing that we haven't
• 15:00
  Speaker 1: talked about is the tax side. And this ETF use
• 15:05
  Speaker 1: is structured a little differently than USO. And I just
• 15:08
  Speaker 1: want to take a moment to talk about that because
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  Speaker 1: it is, Andre, an open-ended investment company. What does that mean?
• 15:14
  Speaker 1: And what does that have to do with taxes?
• 15:16
  Speaker 2: Let's just try to simplify it and forget the terminology. Essentially,
• 15:19
  Speaker 2: when you're invested in something like USO, you could get
• 15:23
  Speaker 2: an unexpected tax bill regardless of whether you have sold
• 15:27
  Speaker 2: the ETF. So based on the structure of that actual,
• 15:31
  Speaker 2: the way it's organized and structured, whatever happens on the
• 15:34
  Speaker 2: fund level could affect you as an investor because in reality,
• 15:38
  Speaker 2: you are a partner. Now with you, the difference is
• 15:41
  Speaker 2: it's structured more like your everyday ETF. your tax bill
• 15:46
  Speaker 2: is contingent upon your activity with the fund. Whether you
• 15:50
  Speaker 2: buy or sell it or make a profit or a loss,
• 15:53
  Speaker 2: that is what will drive your tax liability or your
• 15:57
  Speaker 2: tax position. So that's the upside of an ETF like
• 16:00
  Speaker 2: this in the way that it's structured compared to an
• 16:03
  Speaker 2: older ETF like use.
• 16:05
  Speaker 3: The other problem with these commodity future ETFs generally, although
• 16:09
  Speaker 3: some have solved this, is in USO, for example, the form,
• 16:14
  Speaker 3: the tax form you get is called a K-1 and
• 16:16
  Speaker 3: it comes like at a different time. And I've never
• 16:19
  Speaker 3: filled one out, but I remember interviewing people for my
• 16:21
  Speaker 3: first book about it. And one lady said, look, it's
• 16:24
  Speaker 3: not the end of the world, but it sucks. It's
• 16:26
  Speaker 3: like a paper cut. You know, it's just annoying as hell.
• 16:29
  Speaker 3: And nobody likes that. So there's actually some commodity ETFs
• 16:32
  Speaker 3: that use a structure where they can avoid the K-1
• 16:35
  Speaker 3: and they put no K-1 in the name. That's how
• 16:38
  Speaker 3: brutal that tax form is, especially for advisors. And this
• 16:42
  Speaker 3: does not have a K1. Use doesn't, USO does. And
• 16:45
  Speaker 3: not having a K1 is a nice feature, but it's
• 16:49
  Speaker 3: also not the end of the world. I mean, some
• 16:51
  Speaker 3: people go, when it comes to taxes and tax forms,
• 16:54
  Speaker 3: I think there's just such a crazy reaction and fear
• 16:58
  Speaker 3: of all that stuff. But anyway, good to just get
• 17:01
  Speaker 3: all that information out. It's just another reason the commodity
• 17:04
  Speaker 3: futures area is a rated R or red light because
• 17:07
  Speaker 3: it's just so much to untangle here.
• 17:10
  Speaker 2: Yeah, definitely buy everywhere.
• 17:11
  Speaker 1: All right. Andre, thanks so much for joining us on
• 17:14
  Speaker 1: this episode of Trillions.
• 17:14
  Speaker 2: Thank you so much for having me, guys.
• 17:23
  Speaker 1: Thanks for listening to Trillions. Until next time, you can
• 17:26
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  Speaker 1: Bloomberg Podcast. Bye.