WTF WTI: An Oil ETF Goes Wild

whacking one of those like industrial parks. Back back when I landscaped, I'd have to just take the weed whacker out sometimes and just mow down a bunch of like large weeds. It was similar to that, except a razor. The haircut is the thing I can't wait for. Uh, truly will like basking the best haircut of my life when I once I get out of my house, it's gonna feel good. I think barbers are going to get really good tips. Uh. It's like a one year It's

a one year subscription. I'm going every two weeks. Uh. Put enough about haircuts, Eric, last week saw some crazy stuff, specifically in the oil market. Speaking of haircuts, Yeah, speaking of haircuts and e t f s were all wrapped up in it. What happened, Uh, just the real brief story is with the lockdown, nobody's moving, and when nobody moves, nobody demands oil. So oil the whole oil sector has major problems. Right, there's a supply glut, and at one

point the May contract went negative. I think these negative right, so negative oil became a big, big talking point. This is about a week ago and an e t F. USO has been really in the center of this whole oil debacle and USO for a long time track the front month oil future. But it rolls out of it, uh, a couple of weeks before it expires, so it was

already out of the May contract during that week. However, it then turned to June and there was a huge question on whether June would go negative because again nobody wants oil. People are almost willing to pay you to take it. And then USO abandoned its basically it's philosophy or its rules of what it was going to track, and it started moving down the curve said we're not

going to be all in June. Now, we're gonna move to July a little oh, no, no no, we're gonna move to August two, now September, now October, and then at the last time I checked, it's actually holding June contract, so it's done everything to get away from the sort of front month contract that is going through hell right now. So this was something we want to debate with with our guests. Who is Peter Schure. He's the head of macro strategy at Academy Securities, which is a broker dealer.

He invests in stocks and et fs on behalf of individuals and companies. So we're gonna kind of dive into this topic a little bit with him and just try to make some sense of it because it is obviously highly technical. It's a commodity, which is a thing that we've talked about before on Trillions, and a lot of people are just left scratching their heads about like what

just happened and could it maybe happen again? Even I like to look at news mentions and Twitter, you know, uh a sentiment and USO was tweeted about more last week than x I V was when it imploded. So this has become a huge issue, and I think part of it is is the u s O has attracted some retail investors, and some people argue, and I agree to the to the to an extent, that it's kind of a wolf in sheep's clothing. It's way more complex

than than retails should be messing with. And should you have democratized oil futures is a whole another debate that could have been going on for the last fourteen years, but it's brought it to light now because of what's happened this time. I'm trillion, w T F w T I, Peter, Welcome to trillions. Thanks. I love that. WTF about w T I. I have to say that I'm very jealous of you not needing a haircut. I've actually been doing

my own haircut. I invested in one of those wall things a long time ago, so usually only use it in emergencies, and it's been an emergency even by my standards. So you did not take a haircut on this USO business because you are really just not a fan of this instrument, are you. No, I've had a lot of difficulty with it over the past, you know, recent times. You go back and I think, as Eric talked about, we talked about vix ets being able to blow up and they've done a lot of work on that, and

they ultimately did blow up. And I think there was some similar flaws on the vix et F that are maybe in some USO. It didn't get to track the attention because I think vix was such a fast money trading vehicle. Plus Vix no one really care about fixed. Now these problems have moved into the oil and everyone cares about oil. Everyone looks at oil um. So one of the big problems that I think is just starting to be addressed is this product has done phenomenally well.

So I from about a billion and a half of a u M for most of the past year to skyrocking over four billion, so all of a sudden, it has a much bigger impact on the market than it used to. And that's also when oil was down around fifteen to twenty instead of thirty five to forty five, So it wound up holding anywhere from t to more of individual futures contracts. And if you think about commodities trading, any trading on stock side, right if you own more

than five percent, you have to make disclosures. I think the Hunt Brothers got shut down for cornering a commodity at so they became to a large degree the tail wagging the dog in this space, and right now I'm not sure what to do with it. Eric, how much of the carnage that we witnessed was really because of the USO as an as a trading vehicle. Yeah, so it's all mixed together. It's hard to piece out how much is USO versus how much is people just hating oil.

I think those two things would be created like a downward spiral. This is a once in a lifetime earthquake in oil. I mean, the whole economy shut down, right the the literal oil that oils our economy is oil, and nobody wants it right now because nobody's moving. So that's what's going on in you know. Just that's something I think on the positive side that I think it's

lost in a bit of these headlines. As one, USO was not in that May contract, so they've already been out of it, so that wasn't directly at their function. And only about seven thousand contracts traded at a negative price. So there's these great headlines of how it went to minus thirty seven, But the v whop or the average weighted price on that Monday, I think was still ten dollars. So there are a lot of weird things going on

that day that had enough to do with USO. But what we're seeing is that it's now translated into everyone who speculates an oil traditionally speculated in that front contract, and now that's almost a no no. I think another issue to understand here is that USO is fourteen years old, and I've been tracking it for about the whole time. I think I started covering e t f s raight

on after the time it launched. And every four or five years, oil goes so low that it makes like the CBS Nightly News, and then people like my dad and my you know, college roommate, they email or text me and say, hey, I'm thinking of buying this u S so I know oil can't go any lower, and so it attracts these tourists. We called a tourist trap,

and that's what X I V was. Also, I think there's certain e t f s that, as Joel Unit, We've talked about this all time, they are rated R where they should be labeled rated R, that they should be for hedge funds and traders who do like the fact that you can trade oil futures like equities. These are what we call the exotic rated R areas where two people who know what they're doing it's fine. Uh, it's when they attract tourists and become a bigger fish in a small upon which they swim in and we

really get these problems. And USO is per case in point of that. So again, I've always called for this movie like rating system, which probably could have kept some of these people out of USO if they knew, oh,

it's rated R, it's got a red light. I also think that there was multiple leveraged oil et s that shut down about a month ago in the first round of this crisis, and they they're gone, right, So a lot of the adrenaline junkies and hardcore types have probably moved over to u s O too, So USO probably, if I'm guessing the people who run it are probably like, look, we we wanted to get big, but not this big. That makes a ton of sense. I like your idea.

I think we've talked in the past having that sort of you know, warning label on some et f where people realize it. And I think the other thing was that, you know, we've always been more probably concerned about leveraged ETFs and when something can go negative and all of a sudden becomes leverage, and that's something I don't think anyone was expecting on something like these futures contracts where if you the stock the worst I can go to zero.

The ETFs protected because it has one to one and unlike those leverage ETFs, all of a sudden, if you can go negative, you're not protected here. So I think that's a reshift in how we can think about these commodity based or sorry, these futures based ETFs. And Peter, can I ask you one question. So we've debated that. Peter ibs me a lot on ETF issues, and we have a we have nice debates. The most recent one was he was like, this thing doesn't really track what

it's supposed to track anymore. It's supposed to track the front month oil futures. Right that way, when oil goes up, it has a good, a good pop to it. It's very correlated to spot. But now that it's tracking like all these months down the curve, it's less correlated. So it's become like almost like a water down Front Month Oil Future e t F. But I I guess I

would ask you, Peter Um, what should have happened? Because if it just held June, it was being told by people that this could go negative and you could end up owing money and the investors in the fund could owe money. It could be a real train wreck. Do you don't you think they took the lesser of two evils road? And what would you have done? You know, I think that's a really really hard question because silly in hindsight. Now, had they just stayed in June, June rebounded,

they look like they would have been fine. Had they stayed in June, we don't know what would have happened. Again, that's to me, that's the one issue. I do think we're supposed to look at finding ways to curb how big these products can be, because when you're of a position, you're unwinding now affects that price, especially in this algo driven sort of day where the algos are done nothing. But you know, I hate to use the word train

but that's really what the algos are. There is someone continues to sell no matter how much I lower my bid, and someone considers to buy, so they pushed the markets against themselves. So I think a lot of this would have gone away or not been as much of an issue had they remained smaller. I understand why they got bigger. I understand the appeal, and now you look at it, I like oil here, I'm not sure the best way to play it. I look at the energy stocks. The

energy stocks didn't fall as much. So how do you play this? I don't know the right answer. Peter. When you think about us SO, and we talked about the VIX and the XIV stuff earlier, do you think there's other problems lurking that investors might not be aware of in some other products that could rear their ugly heads

some day. You know. One area that bothers me from time to time is I see a lot of r A s. They do a portfolio analysis and figure out where they want to be, and that's based on certain indices or something, and then they go and pick the e t F that seems to match that with the closest and near and new year to my heart, tends to be the high yield market where you see a lot of analysis done, and yet the e t F s are very much based on the liquid part of the high yield component, and yet a lot of the

index turns tend to be driven by that less liquid component. There also tends to be in the bond market, much more efficiency around managed product and a huge part of that is the new issue game, and to some extent it is a new game is a game because new issues, just like in the equity markets, tend to do very well when they price and trade. But unlike the equity markets, there's one or two new issues every single day, so managers can manage their portfolios very well. So I think

that's one area that's people should revisit. I think there's a lot of good to be said on the fixed income ETFs. I think we had some crazy discounts to nav but I think people do have to take a little bit of care, particularly the high yield, and say

what am I really getting? And maybe it's as overall, coming back Deeric's point about maybe additional warning signs like the stated costs might not be the only cost that you have to look at, and I think that's something maybe um I think ETFs have done a great job fitting into people's portfolils and maybe that's the next step of the evolution is being slightly smarter of when the E t F really fits or when you're kind of, you know, forcing it. So the two things that jump

out to me and what you just said. First of all, HyG tracking the most liquid component of the high yield market. I think that's ultimately part of the reason it never you know, freezes. It just seems to move on and survive these crisis That's good, And I've had some really smart people on Twitter say the problem with h y G isn't it's going to blow up, it's it's so easy to beat. If you're active, you can just h y G. I think of active managers beat h y

G who are in the high yield space. Now, Peter, I will turn this around because AGG is also easy to beat, and I think like six of managers beat the egg way more than the equity side. But in the crisis, those numbers went completely backwards because you are in the maybe the less liquid bonds, the junk of your stuff, the higher credit risk. The FED came in

and obviously bailed out the whole situation. But um, what do you think of that notion where there is a downside to going away from h y G or away from the agg in more risky areas, UM can that blow up if there were no FED. So to me, I view the e t F at least in the fixed income I tend to focus on l q D. On the investment grade, I tend to think about it with a rate hedge. I look at a lot at h Y G G N K, I look a lot at b K l N. I don't look at aggs

so much because that's kind of a boring product. But I think when you step those away, I really view the e t F and fixed income is great trading vehicles. So if you want to capture short term move or you're nervous, they are a great way to express that.

So I think you have to be very careful. And so when if I'm thinking about my portfolio and say I want to move from high yield, say a ten percent allocation to fIF but I think it's temporary, I probably want to put that additional exposure into an e t F where I can control it. Whereas if I really think, okay, for the next fifteen years, this is where I want to be, you can give it to

our asset managers. So to me, I really think about both in conjunction and how to play one off the other because the liquidity is there in high yield um on the e t F s. And I think one thing that we saw this time around, which is actually a problem for mutual funds was I was looking at some of the shorter dated ones, so SP S B which is a one to three year and v C s H which is a one to five year. They both traded I believe at four to five discounts and

NAV which was unheard of. Let's go into that. It's an issue which we talked with Katie. Eric was just like waiting for this. Sorry, so he's been he's been waking up in the middle of the night just being like, can we talk about this on trillions again again? Can we talk about NAV calculations? It just gets me going, yeah, perfect, So these discounts right, how I mean, we've seen that

the N A V s are possibly wrong. Um, you know, whether you're looking at the NAV that the e t F is using or the mutual fund navs that were put out. We just saw another case in India where a debt fund in India had a NAV between twelve and eleven during the whole crisis and then boom, it's got to close up shop because it cannot sell the buns. You're telling me you're you're that all liquid and your

NAV barely budgets because they're using Dale prices. So how much of the E t F discount, in your opinion, is uh just the uh fake? How much is the e t F telling the truth versus the NAV line? So I tend to go a lot more with the e t F So when I look at things. I talked to a lot of people about mark to market and of how they're trying to model something and how

they're trying to calculate NAV. I tell people, if you run your model and you can predict the closing price of the E t F, that's probably a better thing than trying to actually tie out to people's NAV, because I think there's more rational thought into where that E t F traded. So when we see these four percent discounts, I would assume at least that is going to be fake where that NAV is miss marked. And what that became a real problem for is I think this is

very strange. We're gonna have to deal with this is if you are a mutual fund manager, and you allow people to get out at n a V and that n a V is two to three pc wrong. All you're doing is hurting the remaining holders by effectively giving that person a windfall. And the quote unquote smart trade. It sounds awful, but the smart trade was if you owned a one to five year et F sorry mutual fund, you sell that at NAV and then you buy a similar product in the ETF space at a four percent

discount and NAV. So I think this has to attract attention to how are we calculating NAV on these fixed income funds, in particular, what is the right one? What are mutual funds supposed to do? And it's a huge, glaring problem. I think it first came up with Third Avenue a few years ago. I don't know that. I had nothing to do with e T s at the time. It was a very distressed fund that kind of got

in trouble. Um. My understanding is mutual funds have some ability not to let people out at NAV, but I think traditionally they do, so I would I'm kind of with you, especially on fixed income. That difference to NAV is not all garbage. A part of that is the garbage of NAV calculation, right, And the SEC just announced last week they're gonna propose a rule two help to make for better calculations. So it caught their radar as well.

And you know, I think it caught the Treasury Department and Fed's radar because if you go back to the secondary market corporate credit facility that was launched, they specifically allow the asset managers gonna be black Rock to buy e t F s. I'm willing to bet a big part of that as they want to control that discount to NAV because it created so many problems. Is that fishes through the system. Um, So I think there's a

lot going on with that. And people understand a the NAV calculation is bad, but having E t F treated a significant discount to NAV creates its own set of problems. And this is a stop gap solution until we can

figure out better ones. And so, Peter, you know, we have this debate on our team of whether the FED even needed to say they were going to buy e t F s because if the Fed's gonna go out and buy all these bonds, that makes arbitrage easier, and you would think that that discount would collapse naturally because somebody could then um sell the bonds by the E t F and pocket the difference. What's your take on on that, like, were the e t F s really necessary?

And then the second thing is, I guess did the FED go too far in your opinion or did they do just the right amount of uh you know, uh kitchen sinking. So for me, depending on how they ultimately use the E t F s, I like it a lot because it actually takes time to build up a diversified bond portfolio. So if you're gonna invest two fifty billion into the corporate market, um, you need to figure out how to do that. And I think E t

f s are a good starting point. You get a nice diversified portfolio and it can let you move around that. I think it lets them more quickly move to fix things. And again, they really talked about on the bond side only buying one to five year bonds and the E t F side is much more expanded. Did they go

too far? You know? Possibly? I would have liked see them focus on fixing the front end of the corporate market, so one to three years, the money market, commercial paper, because that really is the lifeblood of corporations and it would have left more trading losses. I think once you've gone down this path, it gets harder and harder to

pull back. That's my concern. And somebody, you know, do you think this is good or bad for active managers, because you know some people are complaining that, like you know, price discoveries gone, all the rules are gone, your cf A studies are gone. I mean, nothing matters anymore. I mean what do you think of that sort of bleak outlook of like all the studies of investing. I think

it's overstated. Partly where they've really stepped in is the short data investment grade, which if you look at it short DADA investment grade, there tends to be very little divergence in returns if you buy and hold, so I haven't given up on that. I think it makes it a little bit more difficult. Um if they continue this, it's bad now. How being said all this right, so far they have not bought a single bond. The vehicle to set up the bon by the bonds and ETFs

isn't even up and running. So I think they took a little bit out of drug ease old you know, whatever it takes playbook where he did nothing for six months. It's that mere threat because I think you know, and to me, this is one thing that ties in really importantly. When the FED does things, I view them that they can either fix a liquidity problem or a risk problem. And to me, a liquidity means there isn't enough money for people to buy what they want. And I think

that's what happened in the repo market. There were so many rules blah blah blah. When we looked at what was going on here. People wanted to buy these bonds at cents on the dollar, but they were scared the next price is gonna be on the dollar, so no one actually bought them. And then as soon as the FED said, hey, we along with the Treasury Department are there, they rallied immediately because I think they were miss priced. Okay, So Peter, we talked about USO, we talked about the FED.

Let's talk about some sector outlook stuff. How are you talking to clients about what kind of opportunities are out there right now? So right now, my two favorite sectors are financials and energy. Having said that, I prefer x l E right now. Um x l P I think has a little bit more bang for the buck. I like x L E a little bit um, starting to like high yield, so H Y, G J and K there. I actually prefer some of the clothes and funds um

as we move um elsewhere. I think that also to translate well into the Russell two thousands, so I'd start overweighting I w M. I think we're gonna see a faster recovery than people have been discussing. And more importantly, I think we're gonna see a shift where we get away from fixating on the virus to rebuilding our supply chains, because I do think we are going to try and pope production back from China and the infrastructure spending around that.

So anything that benefits from that, I would like to me. The safest risk reward are, you know, financials who I think have been overly punished. An XL E, which I think has a big chance to pop, and I like how it's been trading through this, and then beyond that, I think we're gonna be sitting there and strategizing how

is the economy gonna look a year from now? And I think even to the extent we recover back jobs, those jobs are gonna look very different than the jobs we had in January twenty twenty, and which companies win and lose will determine a lot. And is your xl E outlook based on just it's oversold it's going to have a rebound pop or is it? Do you have any broader sense because energy in a general sense has been sort of, um, pretty defeated lately because of d

SG and climate change. In these longer term outlooks, yeah, I think one we will get back to driving, we will see people on the road, So the economic recovery is gonna help boost there. I think people forget just how quickly these energy companies, you know, pull back and E s G. I think it's going to be there as a real investing thesis. But on the other hand, as an individual, you know, five dollars gasoline or four dollars gasoline makes you know, electric look kind of interesting.

Two dollars or dollar fifty gasoline and you're like, you know, maybe I'll wait five years before spending that extra eight grand to get the vehicles. So I think the low cost will change how some people think about it. And I also think E s G investing is gonna get a little bit more sophisticated. Um where I think it's been very superficial to this stage. And that's also part

of my thesis on the supply chain repatriation. I think E s G is gonna start saying the companies, hey, if you produce everything in China or one country, we might ding you because that's not good governance. And more importantly, if you're using suppliers who have questionable practices, we're gonna attach those questionable practices to you. So I think there's gonna be a lot and I think E s G is going to evolve into a more sophisticated and even

more thoughtful process. So it's not gone away, so no one really talks about it for the last month or so, but I think it's gonna come back and it's gonna be a little bit more thoughtful, a little bit more interesting. All right, Peter, thanks for joining us on trillions, Stay safeout, thanks for having me, Thanks for listening to Trillions until next time. You can find us on the Bloomberg terminal, Bloomberg dot com, Apple Podcast, Spotify, and wherever else you'd

like to listen. We'd love to hear from you. We're on Twitter, I'm at Joel Webber Show, He's at Eric Faltunus, and you can find Peter at t F m k t S. This episode of Trillions was produced by Magnus Hendrickson. Francesca Leedy is the head of Bloomberg podcast ye