After I wrote an introductory series on investing in natural gas, a lot of Fools had questions about natural gas ETFs. Namely, what are they and are they worth investing in? This article aims to outline the natural gas ETF basics for interested investors.
Exchange-traded funds are typically funds composed of a variety of stocks you can buy and sell shares of on one of the exchanges. They've been around since the early 1990s but have become more popular recently. There are many reasons to buy or not buy ETFs in general, but natural gas ETFs come with their own specific set of pros and cons.
Natural Gas ETFs
Unlike most ETFs, most natural gas ETFs reflect the price of the commodity instead of the performance of a group of stocks. One of the most popular natural gas ETFs is the United States Natural Gas Fund (NYSE: UNG) , which measures the changes in natural gas futures contracts traded on the New York Mercantile Exchange. The price of natural gas has declined significantly since 2008, and futures trade for less than $4 per MMBTU. The year-to-date return of this particular ETF is a loss of 24.8%. A similar ETF, iPath Dow Jones-UBS Natural Gas Subindex Total Return ETN (NYSE: GAZ) , is down 17.6% this year.
Bird of a different feather
There is another option for ETF-inclined investors, however. The First Trust ISE-Revere Natural Gas Index Fund (NYSE: FCG) is made up of equities instead of futures. Thus, the fund's performance is tied to the performance of actual companies and not related at all to the monthly price of futures contracts.
The companies below are the top 10 holdings in the fund and account for 36.25% of its assets.
ExxonMobil (NYSE: XOM)
Questar (NYSE: STR)
ConocoPhillips (NYSE: COP)
Statoil (NYSE: STO)
Royal Dutch Shell (NYSE: RDS-A)
Range Resources (NYSE: RRC)
Southwestern Energy (NYSE: SWN)
Anadarko Petroleum (NYSE: APC)
Ultra Petroleum (NYSE: UPL)
Cabot Oil & Gas (NYSE: COG)
Source: ETFDB and Yahoo! Finance.
The 52-week performance of these stocks varies widely, which is part of the appeal of ETFs. This ETF is only down 3.6% this year.
To fully grasp the disparity between an equities-based ETF and a futures-based ETF, consider the performance of UNG and FCG together over the past year.
The downsides to futures-based commodity ETFs include contango and the weather. Contango is a term that refers to the rollover of futures contracts. Fool Dan Caplinger explains it pretty clearly:
The culprit is the futures market. These ETFs rely on futures, rolling into new contracts every month as the old contracts approach expiration. But because new contracts in these markets tend to have slightly higher prices than the old ones -- a condition known as contango -- each roll costs the ETF a bit extra. Those bits add up over time to create a huge drag on performance.
On top of that, things like the weather will affect these funds as well. A warmer-than-usual autumn on the East Coast has also affected gas prices: East Coasters aren't using nearly as much gas to heat their homes, driving prices down further.
There are many ETFs out there that are worth taking advantage of, but generally speaking, when it comes to natural gas, good old-fashioned equities are the way to go.
For more information about ETFs, click here to check out The Motley Fool's Special Free Report "The Shocking Can't-Miss Truth About Your Retirement."