Barclays Bank filed with the Securities and Exchange Commission (SEC) for the right to launch their third iPath exchange-traded note [ETN]. The new ETN will track the Goldman Sachs Crude Oil Total Return Index, effectively tracking the value of a futures-based exposure to the price of crude. It has the benefit of the perfect ticker symbol: OIL.
ETNs are publicly traded, index-linked debt instruments that function much like exchange-traded funds [ETFs]. Barclays launched its first two ETNs – tied to the Goldman Sachs Commodity Index (ticker: GSP) and the Dow Jones AIG Commodity Index (ticker: DJP) – in early June. We covered the launch here, in an in-depth article that explores the important differences between the ETNs and traditional ETFs.
When you buy an ETN, you are not buying a stake in the underlying commodity – in this case, oil. Instead, you are buying a senior debt note from Barclays. Barclays promises to pay you the exact return of the underlying commodity index, minus an expense ratio of 75 basis points per year. You have no long-term tracking risk against the index, as you do with traditional ETFs. Instead, what you have is credit risk -- the risk that Barclays will go under and won’t pay up when the note comes due (in 2036). You can, of course, sell the note on the stock exchange in the meantime – and as long as everyone trusts that Barclays is in good shape, the ETNs should retain their value.
The ETNs represent a nifty product structure that is gaining respect and assets in the market. Already, GSP has attracted more than $40 million in assets, and DJP has pulled in more than $130 million.
The new oil fund tracks the Goldman Sachs Crude Oil Total Return Index, which measures the performance of a simple investment in oil futures. Performance includes the change in the price of the futures contracts, the “roll yield” (positive or negative) that comes from rolling over the contracts from one month to another, and the Treasury Bill rate of interest that could be earned on collateral funds.
Unlike an increasing number of commodity-based funds, the GSCI Total Return Index does not finesse the “roll” of the futures contracts to maximize profits: Contracts are simply rolled from the expiring month to the next month. As a result, the index may lag other strategies – especially if the oil markets remain in contango.
The closest competitor to the new OIL ETN will be the U.S. Oil Fund (ticker: USO), a true ETF that provides similar exposure to crude oil. USO currently charges just 50 basis points in expenses, and incorporates a roll mechanism that may be more efficient in the current market than the new OIL ETN. The ETN, on the other hand, may have the advantage on the tax front. Although the IRS has not yet ruled, Barclays believes that shareholders in the new funds will never have to pay capital gains distributions while holding the fund – their only tax liability will be when they sell the fund. In contrast, shareholders of USO may have to pay taxes on distributions from the rolling of contracts in the fund.