Prior to the evolution of exchange-traded funds (ETFs), the way most investors obtained exposure to oil was via energy stocks. Oil is one of the most heavily traded commodities, and issuers of ETPs have seized upon that theme by bringing to market a scores of non-equity oil products over the years. That includes the United States Oil Fund LP (ETF) (NYSEARCA:USO).
The USO, which tracks front-month West Texas Intermediate futures, is the king of futures-based oil ETFs.
Issuer U.S. Commodity Funds gives the long explanation of the fund:
“The investment objective of USO is for the daily changes in percentage terms of its shares’ NAV to reflect the daily changes in percentage terms of the spot price of light, sweet crude oil delivered to Cushing, Oklahoma, as measured by the daily changes in price of USO’s Benchmark Oil Futures Contract, less USO’s expenses. … USO invests primarily in listed crude oil futures contracts and other oil-related futures contracts, and may invest in forwards and swap contracts. These investments will be collateralized by cash, cash equivalents, and US government obligations with remaining maturities of two years or less.”
The short version: When you buy USO, you’re not really buying oil, per se. There’s no barrel that you can collect by turning in your ETF units.
But you’re still more closely investing in oil than you can through energy stocks like Exxon Mobil Corporation (NYSE:XOM) or Schlumberger Limited (NYSE:SLB), as you’re invested in the same futures contracts that many pros and bigger investors use to invest in oil.
USO: Big, But Not Perfect
The USO ETF is home to more than $2.8 billion in assets under management, making it one of the largest commodities funds in America. With average daily volume of 21.9 million shares, which works out to be about $2.3 billion in dollar terms, USO is also one of the most heavily traded commodities funds, underscoring the professional community’s use of this products.
However, neither of those factors mean USO is a perfect investment. Far from it.
Although USO is not a leveraged oil ETF, it still comes with one of the same disclaimers: The longer you hold it, the bigger your potential for disappointment.
See, because it constantly rolls over derivatives and futures exposure, not only are its costs high (0.72% per year, or more than triple the average ETF’s yearly fee), but that constant rolling mean the fund can (and does) deviate from the price of spot crude.
The ETF’s “method is particularly sensitive to short-term changes in spot prices, but can also result in heavy roll costs. That makes USO a great vehicle for riding short-term moves in crude prices, but long-term holders may want to look at other options,” according to ETF.com.
Simply put: If spot oil prices jump 20% in a year, it’s unlikely that USO will sport a comparable gain.
The long and short of investing in this fund is that it’s an imperfect way to invest in oil, but as far as faithful methods go, retail investors like you and I have few options anyway. This ETF is an imperfect proxy, but it hasn’t drawn in assets for nothing, either.