An unprecedented crude oil price crash to negative territory on Monday and a spike in oil price volatility triggered sharp movements in two of Horizons ETFs Management (Canada) products. This prompted the fund manager to halt new direct investments in the funds on Tuesday and to warn investors to avoid buying the shares on the TSX.
It’s rare to see a financial product vendor publicly discouraging the purchase of its own products. The mayhem during the crude oil market crash where commodity prices go negative is a rare feature too.
What happened as oil crashed?
Shares in the Horizons BetaPro Oil 2X Daily Bear ETF (TSX:HOD) rose 170% to a high of $35 before closing up 98% high on Tuesday. The price spiked as investors rushed to pick the spoils after oil prices got crushed on Monday.
The HOD ETF is a leveraged (and high risk) fund that bets on the downside of oil. It seeks daily investment results that correspond to twice (200%) the opposite of the daily performance of its underlying index: the Solactive Light Sweet Crude Oil Front Month MD Rolling Futures Index ER.
Investment returns on the HOD were phenomenal when oil prices turned negative for the first time ever on Monday.
Crude oil futures traders are dumping short-term oil futures en mass due to oversupply and storage concerns. Lockdowns during the COVID-19 pandemic and business shutdowns have killed oil demand, yet oil rigs, which are expensive to shut down, continued to pump barrels upon barrels of crude onto the pipelines. Global oil storage facilities are expected to fill to the brim soon.
On the contrary, the Horizons BetaPro Oil 2X Daily Bull ETF (TSX:HOU), which bets on higher oil prices daily has plunged. Shares were down 25% on Tuesday.
Crude oil ETF manager suspends new investments…
Horizons suspended any new subscriptions into both crude oil ETFs on Tuesday due to extreme volatility in oil futures prices during the crude oil crash.
“The manager accepted all subscriptions received this morning before the 9:30AM deadline and has now suspended new subscriptions for shares of the ETFs until further notice. Redemptions will continue to be accepted in the normal course,” a press release revealed.
This is understandable given that it’s challenging to price new fund shares when the underlying asset is extremely volatile. Much could change between the times new investments are accepted and the fund traders fully deploy the new equity.
I strongly believe that acute volatility and high leverage make it challenging to efficiently price and execute mandates. As such, the underlying net asset value after funds deployment could vary materially from initial pricing and cause significant underperformance.
… and discourages buying shares on the TSX
Horizons strongly discourages purchases of the two leveraged crude oil ETFs shares on the TSX secondary market right now.
It’s highly likely that shares will trade at high premiums to their net asset values as investors continue to trade in the units while subscriptions of shares are suspended.
High trading premiums would speak to significant overvaluation. Investors could lose their shirts when share prices finally correct back to reasonable ranges near their fundamental value.
Foolish bottom line
It’s frustrating that interesting betting products on crude oil prices won’t allow new money during the best trading times.
That said, sharp daily swings in oil prices mean high daily returns, and elevated daily losses too. Further, the two times leverage in the affected crude oil ETF funds amplifies the daily gains and losses.
The two funds are definitely not for the average risk-sensitive investor. They aren’t great candidates for long-term buy-and-hold investors either. The fund manager actually encourages daily checking and monitoring of returns.