Futures-Based ETFs: Understand The Risks

After a year of robust trading in the commodities market, regulatory action has been threatened on select exchange traded funds (ETFs) that are seen as problematic. The scrutiny has highlighted the differences between certain types of funds, giving investors an education.

The spike in investor interest in funds like United States Natural Gas (UNG), PowerShares DB Commodity Index Fund (DBC), PowerShares DB Agriculture Fund (DBA) has resulted in creation halts and strategy reconstruction as the Commodity Futures Trading Commision (CFTC) scrutinizes the industry, writes Don Dion for TheStreet.

The iPath Dow Jones AIG Platinum TR Sub Index (PGM) recently had to halt creation in order to remain within position limits.  And most recently, PowerShares DB U.S. Dollar Bullish (UUP) had to rush to get  approval to create new shares as trading volume suddenly picked up.

Traditional ETFs track underlying indexes, which is made possible through the share creation and redemption process. When the creation process is halted, it creates premiums to an ETF’s underlying value. The result is an environment good for shareholders but bad for investors chasing the trend.

As an investor, you should be aware of when an ETF’s share creation has been suspended and understand that if a futures-based ETF runs out of shares, this could happen. If you’re already holding such an ETF, monitor your funds to be sure that all is running smoothly. The risk of holding a fund with suspended share creation is that when normal trading resumes, losses could be incurred as the premium disappears.

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