Understanding an ETF’s strategy is critical. For many ETFs this means understanding the index that the ETF seeks to track. What securities are included/excluded from the index, how the index weighted and how often the index is rebalanced. Then, importantly, how does the ETF seek to track the performance of the index? Is it a full replication of the index, where the ETF will physically hold each individual security? Or an optimisation approach?
This is where a sampling process is conducted, aiming to provide an accurate representation of the index without owning every security. This can lower the trading costs and costs associated with portfolio maintenance but also increase the tracking error. Some ETFs may hold the equivalent foreign domiciled ETF and appropriate levels of foreign cash to achieve the desired strategy.
Then there are synthetic ETFs, which don’t hold physical assets. They will instead use derivatives to achieve the desired outcome. Outside of the added counterparty risk, synthetic ETFs require a greater level of knowledge on how the underlying net asset value is calculated and the volatility of the underlying derivatives.
Given the current level of crude oil prices and heightened market volatility, it is important that investors understand that the BetaShares Crude Oil Index ETF – Currency Hedged (Synthetic) (OOO) does not seek to track the crude oil spot price. OOO seeks to track the S&P GSCI Crude Oil Index Excess Return hedged into AUD. This index tracks the performance of the West Texas Intermediate (WTI) crude oil futures which can be materially different to the current spot price. Futures contracts will need to be periodically rolled over to maintain exposure. The WTI is in contango, this is where the futures contracts trade at a premium to the sport price. A key reason for the premium is the increased cost of physical storage in an oversupplied market. The higher futures prices will eventually move towards the spot price as it reaches maturity. The roll-risk in OOO is currently very high and could result in further material decreases in the NAV.
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