Futures-Based Commodities ETFs
By: Ilan Guedj, Guohua Li, and Craig McCann (Jan 2011)
Published in The Journal of Index Investing, Summer 2011, Vol. 2, No. 1: pp. 14-24.
Commodities Exchange Traded Funds (ETFs) have become popular investments since first introduced in 2004. These funds offer investors a simple way to gain exposure to commodities, which are thought of as an asset class suitable for diversification in investment portfolios and as a hedge against economic downturns. However, returns of futures-based commodities ETFs have deviated significantly from the changes in the prices of their underlying commodities. The pervasive underperformance of futures-based commodities ETFs compared to changes in commodity prices calls into question the usefulness of these ETFs for diversification or hedging.
This paper examines the sources of the deviation between futures-based commodities ETF returns and the changes in commodity prices using crude oil ETFs. We show that the deviation in returns is serially correlated and that a significant portion of this deviation can be predicted by the term structure of the oil futures market. We conclude that only investors sophisticated enough to understand and actively monitor commodities futures market conditions should use these ETFs.
Leveraged ETFs, Holding Periods and Investment Shortfalls
By: Ilan Guedj, Guohua Li, and Craig McCann (Aug 2010)
Published in the Journal of Index Investing, Winter 2010, Vol. 1, No. 3: pp. 45-57.
Leveraged and Inverse Leveraged ETFs replicate the leveraged or the inverse of the daily returns of an index. Several papers have established that investors who hold these investments for periods longer than a day expose themselves to substantial risk as the holding period returns will deviate from the returns to a leveraged or inverse investment in the index. It is possible for an investor in a leveraged ETF to experience negative returns even when the underlying index has positive returns. This paper estimates the distributions of holding periods for investors in leveraged and inverse ETFs.
The SLCG study shows that a substantial percentage of investors may hold these short-term investments for periods longer than one or two days, even longer than a quarter. The study estimates the investment shortfall incurred by investors who hold leveraged and inverse compared to investing in a simple margin account to generate the same leveraged or short investment strategy.
The study finds that investors in leveraged and inverse ETFs can lose 3% of their investment in less than 3 weeks, an annualized cost of 50%.
Structured Products in the Aftermath of Lehman Brothers
By: Geng Deng, Guohua Li, and Craig McCann (Nov 2009)
SLCG's prior research showed that structured products were poor investments because they were significantly overpriced when offered and were, at best, thinly traded thereafter. SLCG concluded that overpriced structured products survived in the marketplace because structured products' opaqueness obscured their true risks and costs and the high fees earned by underwriters and salespersons.
The current SLCG study presents a brief history of the structured products program at Lehman Brothers and illustrates many of its points with Lehman structured products examples including Principal Protected Notes, Enhanced Return Notes, Absolute Barrier Notes, Steepeners and Reverse Convertibles. The study reports that the spectacular failure of Lehman brothers in September 2008 left investors holding more than $8 billion face value $US-denominated structured products. Dr. Craig McCann, the study's principal author, explained that the Lehman experience is especially instructive of the opportunity for mischief presented by financial engineering; faced with increasing borrowing costs Lehman stepped up its issuance of structured products where its credit risk would not be priced into the debt.
