All ETFs are not created equal

by Manshu on May 24, 2011

in ETF

Continuing with the theme of ETFs this week, today I’m going to write about something that doesn’t impact Indian investors yet, but will surely impact them in the years to come.

Currently, the name of the ETFs pretty much lets you know what it means and there’s not much difference between different ETFs of the same category – for example you can look at the performance of any gold ETF over a certain period of time and find that all of them were fairly close in their performance.

This is because their underlying is the same and all of them buy the same gold, and it’s price movement is the same for everyone.

However, this won’t remain the same forever, eventually there will be fund providers who will create a gold ETF that doesn’t actually own physical gold but only replicates its performance by buying Futures contracts, and there may also be gold ETFs that own shares in the companies engaged in gold mining, trading or dealing with jewelery.

For example – I took 4 oil ETFs that trade in the US market, and saw how they performed in the last year.

 

Oil ETFs Last Year
Oil ETFs Last Year

You will be amazed to see the variance in performance of these funds. While the best performing went up by about 50%, the worst performing went by just 22% or so.

OIH is a fund that invests in oil producing companies whereas USO is the ETF that tries to replicate the performance of oil with Future contracts.

The lesson here is that even though you’d think of both these ETFs as oil ETFs, the performance between them varies a lot, and before buying into any ETF you need to see what they are going to buy, and then keep an eye on how the fund is performing relative to its peers.

The big question here is how to know which fund will perform well without the benefit of hindsight, and apart from looking at a fund and finding consistent patterns I can’t think of anything else. This is probably another case where you can spread your investment between funds of different kinds and diversify a little.

{ 3 comments… read them below or add one }

kabir May 25, 2011 at 3:39 am

if you look only at the initial part of the chart (before Oct 2010), USO (blue) seems to be consistently outperforming OIH (red). At this time, USO would have seemed to be the better investment….and would have underperformed later!
An apt example, which illustrates the futility of trying to guess which fund will be the best performer!
Perhaps, if we look at long term charts, both may turn out to be having a similar return??

Reply

Manshu May 28, 2011 at 10:24 am

If you increase the time frame to 5 years, then the performance is even more varied. USO lost close to -53% whereas IEO only 1% or so! It’s just that the underlying of these are different so the performance is also different.

Reply

valueviews May 25, 2011 at 10:24 am

IT is imp to understand in which product u r placing ur money and in turn what is going to be the underlyin asset in that product.
Performance may vary from year to year .

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