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.
There’s obviously high demand for these products, and neither the limits nor closures of funds (as in the case of the PowerShares DB Double Long Crude Oil (DXO) exchange traded note (ETN)) will erase the demand. What we could very well see is some funds closing, then reopening in a smaller form with higher expense ratios. These products are so popular that investors may be willing to pay more to own them.
Meanwhile, Deutsche Bank has been quiet about its exact reason for closing DXO. Some reports, says Matt Hougan for Index Universe, have noted that DXO might have been concerned about the size of its positions and any upcoming CFTC limits. But Hougan notes that perhaps the New York Mercantile Exchange might have exercised a “discretionary power” that it has rarely used.
There’s no federal position limit, but the NYMEX actually has two levels of such limits for the majority of commodities, and that includes oil. Firms are limited to 3,000 contracts.
For more information on commodities, visit our commodity category.
Max Chen contributed to this article.