Comparison of Top Exchange Traded Funds
for
Equity and Commodity Markets
This articles examines the performance of the two beacons over the span of 5 years ending in spring 2012. On one hand, the energy branch of the stock market has a bunch of unique properties due to its heavy reliance on the fortunes of crude oil in the real economy. Despite the close linkage to the physical market, though, every exchange traded fund is also an equity traded on a stock exchange.
For this reason, a vital question for the worldly investor is the performance of USO and XLE compared to the stock market at large. In the latter case, the flagship fund for the equity market as a whole lies in the tracking vehicle for the S&P 500 index; the exchange traded fund goes by the symbol of SPY.
Given this backdrop, we examine the performance of USO and XLE and compare the results against the turnout for SPY. In the appraisal, the key criteria take the form of volatility, payoff, and risk-adjusted gain.
Chart Action for Exchange Traded Funds
In order to obtain a rounded view of performance, we need to select a time frame that includes a boom as well as a bust of the market. For this purpose, a fitting window is the period of half a decade ending in spring 2012. The interval includes the crash of the stock market in 2008 and 2011, in tandem with the crackup of the energy sector. The tumult in the equity market has been accompanied by similar turmoil in the futures market, where the contracts for crude oil mirror the outlook for petroleum in the real economy.
The chart below, courtesy of MSN Money (money.msn.com), covers a span of 5 years ending in April 2012. The reddish curve depicts the path of the USO fund, which is designed to track the price of crude oil.
On the other hand, the purple arc denotes the course of XLE. The latter vehicle holds the stocks of the producers working in the oil and gas industries as well as the suppliers of equipment and services to the primary vendors.
Meanwhile, the blue squiggle in the chart above depicts the course of SPY. The latter fund tracks the Standard & Poor’s index of 500 giants in the stock market by holding a basket of the corresponding equities. Thanks in large part to the vast pool of assets under management, the index fund is highly efficient. To wit, the tracking vehicle replicates the performance of its target index with hardly any discrepancy.
Getting back to USO, we can see from the chart that the tracking fund for crude oil had a wild ride, especially near the beginning of the 5-year period. The ETF soared until the middle of 2008, then suffered a massive setback over the next half-year and more. In the years to follow, the index fund bounced around without going anwhere fast.
At the end of the evaluation period, USO turned in the worst performance amongst the trio of index funds under consideration. In fact, the chart would suggest that the deadbeat lost roughly 20% of its value over the span of 5 years.
By contrast, SPY was a lot more demure than the two other funds. On the downside, though, the index fund appears to have slipped by a handful of percent during the period of appraisal.
Meanwhile, XLE was more flighty than SPY but less hysterical than USO. The winsome feature of the energy fund was its ability to eke out a few percent in gains over the course of half a decade.
The foregoing chart gives us an intuitive sense of the action in the marketplace. Our next step is to beef up the visceral view with a clutch of numerical data.
ETF Comparison by Volatility and Return
In this section, we examine the numbers for the index funds over the course of half a decade ending in spring 2012. The data in this section come from Yahoo Finance (finance.yahoo.com), the most popular site for investors on the Internet.
Volatility of the Index Funds
In gauging the performance of the stock market as a whole, the S&P 500 index is the benchmark of choice for professionals and researchers alike. As we noted earlier, the popular yardstick is tracked by the index fund marked by the ticker symbol of SPY.
On the whole, the tracking fund does a good job of replicating its target benchmark. The tight linkage is reflected in the beta factor, which denotes the relative movement of the tracker compared to the quarry.
Over the period of 5 years ending in March 2012, the value of beta for SPY was 0.99. The latter figure indicates that the index fund rose by 0.99 percent on average whenever the benchmark itself swelled by 1 percent; and likewise for movements to the downside.
By contrast, the USO fund sported a beta value of 1.32 over the same stretch. In other words, the index fund – whose goal is to track the price of crude oil – bounced around by nearly one and a third percent for every percentage move of the S&P index.
Meanwhile, the corresponding figure for XLE was 1.05. Based on the latter figure, the energy fund was a tad more volatile than the market index for the bourse at large.
Annual Return on Investment
According to Yahoo Finance – which draws on multiple streams of data provided by a band of respectable sources – the “Mean Annual Return” for SPY over the course of 5 years came out to positive 0.31 percent a year. The latter figure is somewhat at odds with the price chart displayed above, which appears to show that the average payoff for the flagship fund was slightly negative.
No doubt one reason for the discrepancy stems from the slight mismatch of time frames. In particular, the foregoing chart spans a window of half a decade ending on 11 April 2012. By contrast, the numeric value for the average return refers to the stretch of 5 years ending on March 31 the same year.
On the other hand, the small difference of a week and a half in the horizon is unlikely to account for the full extent of the discrepancy. No doubt a second reason for the mismatch stems from the iffy nature of information on exchange traded funds: the data available from service providers often turns out to be faulty and conflicting.
The muddled state of affairs is showcased by a contrary piece of information on the same Web page at Yahoo Finance. Before we delve into this topic, however, we should first introduce an additional factor relating to the performance of an asset. In particular, the alpha factor denotes the absolute return on investment for a stock when the volatility of the bourse as a whole is ignored.
According to the data sheet served up by Yahoo Finance, SPY turned in an alpha value of minus 0.06 percent a year on average over the course of half a decade. The negative outcome is consistent with the downbeat turnout for the index fund portrayed by the chart above.
Despite the conflicting information, though, we will not quibble here over small differences in outcome. In particular, the mismatch amongst the figures – in the visual as well as numeric modes – appears to be modest.
For this reason, we will not worry overmuch about the divergent results. The main purpose of the analysis at this juncture is to obtain a rough idea of the comparative performance of the index funds. The review here may then serve as a starting point for further digging by the serious investor. More generally, the prudent gamer conducts a thorough program of due diligence before making a concrete decision to invest in any type of market.
According to the numeric data, the mean annual return for USO was positive 0.04 percent a year. The latter figure turns out to be a mite smaller than the corresponding value of 0.31 percent reported for SPY.
More to the point, however, the value of the alpha factor for USO was deemed to be minus 8.43 percent a year on average. The grody result is more in tune with the outcome in the chart above. The negative payoff also happens to jive with the risk-adjusted gain to be examined in the next subsection.
Turning now to the energy fund, the mean annual return for XLE was positive 0.71 percent. The foregoing numbers are consistent with the price chart, which shows that XLE outpaced both USO and SPY by a clear margin.
In addition, the alpha factor for the energy fund came out to positive 4.55 percent a year. The winsome reading is compatible with the superior performance of XLE depicted by the mean annual return as well as the price chart.
Risk-Adjusted Return
The mindful investor wants to enjoy a positive return on investment in concert with a low level of risk. Unfortunately, the two factors of payoff and risk are in general conflicting traits. Put another way, higher gains tend to require greater risk.
In talking about the perils of investment, a standard mode of risk lies in the flightiness of a security. More precisely, an asset whose price bounces around wildly is deemed to be risky.
From a pragmatic stance, the erratic action in the marketplace can be profiled by a statistical measure known as the standard deviation. For our purposes here, we need only note that a large value for the standard deviation of the price level corresponds to a high level of risk for the asset.
The opposing dimensions of payoff and turbulence can be combined into a single measure of performance called the risk-adjusted return. For this purpose, a popular gauge is found in the Sharpe ratio which refers to the average return divided by the standard deviation.
Over the course of half a decade, the Sharpe ratio for SPY came out to positive 0.14. We can interpret the latter figure by saying that the index fund scrounged up a gain of 0.14 percent for every percentage point of turbulence.
By contrast, the Sharpe value for USO during the period of evaluation was negative; namely, – 0.02. The latter value is consistent with the crummy performance based on the alpha factor.
Meanwhile, the corresponding value for XLE was a Shape quotient of 0.29. The energy fund managed to edge out SPY, which trailed behind with a risk-adjusted gain of 0.14. The flagship fund in turn performed somewhat better than the negative showing turned in by USO.
For the bulk of investors, the precise value of the Sharpe ratio is less important than its relative size. That is, an asset with a higher level of risk-adjusted gain is preferable over a contender with a lower value. Based on the data at hand for the risky gain, XLE managed to trump both its competitors.
Recap of ETF Performance
The foregoing tally of index funds shows that XLE turned in the best performance. By contrast, SPY put in a lackluster showing. Meanwhile USO lagged behind both its rivals by a comfortable margin.
On a note of caution, though, the muster of numeric data was somewhat inconsistent. For this reason, the results presented here should be viewed as suggestive rather than definitive.
Sad to say, but the world of exchange traded funds is rife with scrappy information that turns out to be incorrect, incomplete and misleading. For this reason, the earnest investor has to tread carefully in venturing into the treacherous terrain.
Tips
An investor in any type of market faces a slew of risks both subtle and obvious. A survey of the pitfalls that lie in wait is available in an article titled, “Financial Risk”. A link to the writeup is given in the Resources section below.
An ETF structured as an index fund can provide the deft player with a handy way to outshine the bulk of investors ranging from part-time amateurs to full-time pros. The reasons for the exceptional feat, in tandem with the winning approach, are presented in an article called, “How to Beat the Investment Funds”.
Caveats
As we saw earlier, the information available on exchange traded funds is often incorrect, outdated, and/or misleading. In fact, the case study we examined encountered a problem in which the data displayed on a single Web page happened to be inconsistent.
The welter of pitfalls confronting the hapless investor are explained in an article titled, “Cruddy Information on Exchange Traded Funds”. In addition, the review presents a variety of workarounds for dealing with the muddle in the marketplace.
Of the three funds we examined, USO turned in the worst performance. Unfortunately, the crummy showing is not merely a fleeting aberration but a chronic affliction. In other words, the dismal performance of the tracking fund is slated to crop up repeatedly over the long range.
The main cause of the problem lies in the grind of transaction costs entailed in tracking the market for crude oil. The frictional loss is in turn grounded in the fact that the index fund does not hold a stockpile of petroleum. Rather, the stewards of the vehicle rely on a suite of derivative instruments such as futures contracts and forward contracts.
In theory, the use of secondary assets need not pose a problem in tracking a target market. In practice, though, the indirect approach sets up an additional layer of friction and risk compared to the direct scheme of holding the target asset in its original form.
The detailed reasons for the lousy showing of USO lie beyond the scope of this article. The roots of the underperformance, as well as other bugbears associated with the indirect approach to investment, will be explained in a future article on the strengths and drawbacks of sundry types of exchange traded funds.
Resources on the Web
A review of motley forms of risk is available in an article titled “Financial Risk”.
A survey of faulty information on ETFs, along with countermeasures for serious investors, is given in “Cruddy Information on Exchange Traded Funds”.
The following article talks about the use of index funds in order to trounce the bulk of actors in financial markets, ranging from casual amateurs to committed professionals: “How to Beat the Investment Funds: Outrun Most Mutual Funds and Hedge Funds while Earning a Bonus”.
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