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AP Worldstream: New oil fund deemed too risky for average investors

New oil fund deemed too risky for average investors
 Apr 09, 2006

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A new financial instrument aimed at those pining to profit from the multiyear surge in oil prices is distressing energy and stock-market experts because of the allure and risks it presents to average investors.

The United States Oil Fund, an exchange-traded fund that is expected to debut Monday and whose per-share value is designed to mimic the price of crude oil futures, is most appropriate for savvy institutional investors and may be OK for a small cadre of consumers looking to diversify their portfolios.

But near-direct exposure to volatile commodity markets is not right for those seeking a relatively safe way to increase the value of retirement savings or a nest egg, nor is it a smart way for armchair energy analysts to test their luck, said Ronald Sorenson, CEO and chief investment officer of W.H. Reaves & Co., a New Jersey-based investment firm that has specialized in energy and utilities for 45 years.

“Let's not confuse investing with speculation,” said Sorenson, who prefers to put his clients' money into stocks and mutual funds where they can earn dividends and benefit from corporate share buybacks.

Other analysts said investors should simply be leery of jumping into Wall Street's latest energy-related financial product, likening it to investors' late-1990s urge to ride the Internet bandwagon.

“We hate to see any new fund rolled out right when a sector is red hot,” said Sonya Morris, an analyst at Chicago-based Morningstar who focuses on natural-resource mutual funds and ETFs. “That just attracts performance chasers, and performance chasing is a very dangerous game to play.”

The new exchange-traded fund, or ETF, is being managed by Victory Bay Asset Management LLC of Delaware, and will be traded under the symbol USO on the American Stock Exchange. Victory Bay declined to comment for this story, citing a quiet period ahead of USO's launch.

ETFs have become popular with investors seeking alternative to traditional mutual funds. Like a mutual fund, ETFs include baskets of stocks, or commodities in this case, to help mitigate the risk of investing in just one company. But ETFs are unlike mutual funds in several ways:

_ Their share-price fluctuates throughout the day, allowing investors to act quickly on a trend.

_ New trading costs are incurred each time new shares are purchased.

_ Investors can go short, or bet that the fund's share price will fall.

Of course, it is most likely the prospect of earning money from higher oil prices _ or going long _ that would attract non-professional investors to USO, analysts said.

The price of oil is now close to $70 a barrel after more than doubling over the past three years, and professional commodity traders and hedge funds who wagered correctly on futures markets have no doubt become very rich.

However, these financiers have for decades been making good money, benefiting from even small changes in commodity prices because they have a lot of cash on the line. Moreover, these high-fliers are backed by experience and sophisticated computer modeling, enabling them to place their chips in a way that ensures opportunities for profits no matter which direction the price of oil (or corn or coffee) goes.

The three-year runup in oil prices has also delivered huge profits to companies that produce and refine crude, as well as to their shareholders.

But Sorenson and others noted that the world's largest oil companies primarily use energy futures markets as a way to efficiently buy and sell barrels of crude needed for refineries _ not as a way to make quick profits by gambling on prices. Furthermore, their everyday investment decisions are based on very conservative energy-price assumptions. That way a new oil platform or refinery will remain profitable even if there is a substantial drop in prices.

“If Royal Dutch Shell can't correctly predict the direction of the price of oil, and Exxon can't do it, how am I going to do it?” Sorenson said.

In the prospectus filed with the Securities and Exchange Commission, the investment objective of USO is for the shares' value to reflect the spot price of West Texas Intermediate light, sweet crude _ less fund-management expenses. To achieve this, shares of USO will be indexed to a variety of front-month futures contracts, ranging from oil to gasoline to natural gas.

The fund's managers have structured USO like a commodity pool, which means it won't be as strictly regulated as a traditional mutual fund.

USO's closest relatives on the market right now are highly popular commodity funds such as PIMCO Commodity Real Return Strategy (PCRAX), which uses derivatives that mimic the Dow Jones-AIG Commodity Index, and the Oppenheimer Real Asset fund (QRAAX), which tracks the Goldman Sachs Commodities Index, according to Morningstar's Morris.

These commodity funds provide exposure to a broad set of commodities, such as oil, cattle and coffee, and they do so mainly by investing in the stocks of companies highly leveraged to commodity prices. In this regard, they are less volatile. Traditional commodity funds also differ in that they regularly distribute dividends, which are generally reinvested in the fund.

Phil Flynn, an analyst at Chicago-based Alaron Trading Corp. and one of the more gung-ho oil-market bulls, was enthusiastic about the launch of USO.

Because USO's managers will need to be regular buyers of futures, it could give a slight bump to oil prices, Flynn said, while investors seeking diversification will have a new way “to participate in the incredible moves in oil.”

However, Flynn added, “I probably wouldn't put my retirement money in there.”

Copyright 2006 Associated Press
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