Regulators are zeroing in on commodity exchange traded funds (ETFs), but the added scrutiny could render the entire niche industry impractical if harsh federal limits persist.

Small investors gaining exposure to commodity futures through ETFs have drawn the attention of the Commodity Futures Trading Commission‘s (CFTC) focus in reining in speculation within oil markets, reports Brian Baskin for The Wall Street Journal. The CFTC has prioritized the end consumers of commodities who benefit from lower prices that would result from limits in speculation.

Individual investors use ETFs to pool money to make one-way bets on rising prices and some now say that this has caused runaway buying, which ignores the bearish signs more well-informed institutional investors usually regard.

Regulatory changes would limit the size of ETFs and result in higher costs for investors because legal and operational costs would have to be spread over fewer shares; thus, regulation would reduce the desirability of this commodity investment tool as shares of closed funds deviate from price moves in the underlying commodity.

A potential alternative would be smaller funds to which investors can turn instead of larger funds inhibited by federal limits. But scaled-back ETFs tend to have higher expense ratios, which would make generating positive returns that much harder for funds to achieve. Or, some investors may choose to give up entirely and turn to picking out major energy companies.

John Hyland, CIO at United States Commodity Funds, talked about this issue yesterday on CNBC.

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