Two trends have been noticeable in the investment industry in the past year – the growth of exchange-traded funds (ETFs) and of derivatives. And in the markets, there is seemingly overwhelming demand for commodities, led by oil.
Combine these factors and you have Barclays Capital’s new exchange-traded note (ETN), launched this week and designed to replicate the performance of the Goldman Sachs Crude Oil Total Return Index. Like an ETF, it offers the chance to match an index with a security that can be bought and sold like a stock. But, in the case of this new offering – the third in a series Barclays is calling iPaths as a companion to its iShares ETFs – there is no attempt to replicate that index by buying up the commodities included in it. Instead, the underlying asset you are buying is a note underwritten by Barclays.
After 30 years – the life of the ETN – the note will pay out an amount in line with the increase in the crude index. In practice, it should be easy to roll over into a new note and there should also be no difficulty in creating new notes if demand from investors warrants it.
This has the effect that all concerns about Barclays’ ability to replicate the index can be removed from the equation. The bank will use derivative contracts so that it can be sure to meet the 30-year pay-out but the investor should not need to worry about this. Barclays is guaranteeing that there will be no tracking error and that changes in the price will match changes in the index. The only concern – not a significant one – is Barclays’ creditworthiness.
Barclays claims this simplicity also translates into lower fees for investors. The cost is 75 basis points from the fund each year. Commodities-based ETFs tend to charge in a range of 100 to 150 basis points. There is no charge beyond what you pay your broker. The target consumer, therefore, appears to be someone who already uses a discount broker.
There may be other advantages. The iPaths system has much less friction than the structure adopted by some other commodity ETFs. For example, the launch of a silver ETF this year led to concern that it would move the market as it would need to purchase silver in response to demand. Buying into a bank’s note should be much smoother than buying supplies of silver to be moved into a dedicated vault.
Barclays plainly believes it is on to something. This is the third iPath after offerings that match the Goldman Sachs Commodity Index (which includes 25 commodities) and the Dow Jones-AIG Commodity Total Return Index. It has already filed for five more, including three that will invest in currencies – another asset class that so far has been difficult for retail investors to access.
Intriguingly, it also intends to launch a note to match the performance of the MSCI India index, moving the concept from commodities into emerging markets equities, and another to match the CBOE BuyWrite index. This is an index that mimics the returns made by executing the popular “covered call” strategy – in which short-term call options are written on stocks already held by the investor, with the aim of generating an enhanced return from the premium income – on a basket of the stocks included in the S&P 500 index.
If this is an appropriate vehicle to gain exposure to oil, the broader question remains: is this the time to be investing in oil?
Here there is room for debate. Oil is at historical highs, in nominal terms, although in real terms it is below its highs of the 1970s. The risks in the geopolitical situation are well-known. Apart from the conceivable event of hold-ups to supply from Iran and Iraq, several other big suppliers have political issues – notably Nigeria, which is riven by instability, and Venezuela, whose leader, Hugo Chávez, has an ever-worsening relationship with the US.
Then there is the risk of supply shocks that have nothing to do with politics. This month alone brought BP’s closure of the Prudhoe Bay pipeline.
You do not need to be a Cassandra to see a real risk of oil going higher, even from its present levels.
But there are arguments against this. As John Dizard, the FTWealth columnist, has pointed out in these pages, there appears to be an oversupply of crude oil, with world storage facilities close to their capacity. There is also evidence that at least some of the high price can be attributed to speculative activity. Hedge funds, in particular, seem to have taken to the commodity market in a desperate search for higher returns.
And the volatility of the market is plain. Only in the course of the past week, benchmark crude prices have dropped 7 per cent as the supply shock from the Prudhoe Bay closure proved not to be as bad as first thought, and then the terrorist alert in Britain provoked speculation that demand for air travel and, hence, fuel would fall. Further, there are well-run energy companies whose stock may be less volatile than the price of crude and may provide the possibility of excess returns if the price should rise. So the underlying investment case is far from obvious. But if you want to buy into oil, Barclays’ arguments that this is a good way for a retail investor to do it look well-founded.