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posted on 10 May 2017

Costs Of Oil Price Exchange Traded Funds Diminish Usefulness

from the Dallas Fed

-- this post authored by Sung Je Byun

Crude oil exchange-traded funds (ETFs) are investments designed to track oil price changes. They bear unique costs of which many investors are unaware. Since the first crude oil ETF went to market in April 2006, these costs have been sizable, reducing ETF returns by 1.33 percent per month on top of the average monthly loss of 0.23 percent attributable to weak oil prices.

Historically, only a few investors could participate in the crude oil market because of high fixed costs associated with the acquisition of storage facilities needed to hold the commodity.

Crude oil futures contracts - financial claims for crude oil to be delivered at a future date - were introduced in early 1983. They lowered this barrier by eliminating the need for investors to take delivery. A buyer (seller) of a crude oil futures contract can avoid physical delivery by selling (purchasing) the same futures contract before the contract expires. However, the large standard contract size (currently 1,000 barrels per contract) still limited individual-investor direct participation.

Crude oil exchange-traded funds (ETF), which debuted in April 2006, further reduced barriers to investor access to the crude oil market. The crude oil ETF is a security that tracks oil price movements, providing individual investors with a low-cost way of participating in the market. Because ETFs trade in real time, investors gain more opportunities to respond to oil price movements.

But the strategy comes at a price. While crude oil ETFs may provide attractive investment opportunities, they also include unique costs. Some of these arise H Costs of Oil Price Exchange-Traded Funds Diminish Usefulness by Sung Je Byun from the need to roll over expiring futures contracts. The ETFs also offer only intermittent benefits as a means of portfolio diversification.

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