At a time when the surge of new retail investors is the talk of Wall Street, the worry is that history could repeat.
Right before the fund crashed, mom-and-pop investors had piled into USO to try to surf any oil price recovery. Both the SEC and the Commodity Futures Trading Commission are said to have opened probes into whether the risks of the fund were properly disclosed.
For many pros, the lesson of USO is simply buyer beware. Some argue it shows certain assets shouldn’t be in an ETF wrapper, while others tout the proposed re-naming of fund types being pursued by a group including BlackRock Inc., which they argue would help investors realize the varying risks.
“Not all exchange-traded funds are created equal,” said Ben Johnson, director of global ETF research at Morningstar Inc. “Other non-ETF exchange-traded products or commodity-based ETFs proved to be challenged in a number of regards, and I think it’s time to take a long, hard look at the ways in which risks associated with them can be better highlighted.”
The drama wasn’t limited to oil funds, however. The USO crisis came on the heels of a pronounced bout of turmoil in the bond market, when a rush to liquidate spurred the widest gap between fixed-income ETFs and their underlying assets in a decade.
As debt markets convulsed, the shares of the funds -- which were more liquid -- slumped, leaving them at deep discounts to the value of the bonds they invested in.
It was a moment many naysayers had been waiting for. Their argument had long been that the liquidity mismatch between ETFs and bonds would exacerbate a selloff and destabilize the wider market.
Some niche hedge funds positioned for precisely this type of dislocation, and their bets paid off as the funds tumbled. In their eyes, the plunge in ETF share prices was evidence that fixed-income funds give merely an illusion of liquidity.
It’s a view not shared by the bulk of industry practitioners. The way they see it, when the bond market froze the ETFs didn’t, meaning the funds actually became the best available vehicle of price discovery.
“You saw this huge fall-off in market liquidity, while the ETF market for fixed-income has picked up some of the slack,” said Dan Suzuki, the deputy chief investment officer at Richard Bernstein Advisors.