Horizons shifts exposure in oil ETFs to September contracts

The funds use derivatives for exposure to futures contracts. The firm said that levels of volatility in crude oil futures may lead the ETFs’ derivative counterparties to terminate their forward agreements.

“In discussions with the counterparties, we rolled into the September contract now to significantly reduce the likelihood that we could have a negative futures contract that would require the counterparties to exercise their termination rights and force the ETFs to unwind all their exposure to crude oil,” Horizons President and CEO Steve Hawkins told reporters Wednesday on a conference call.

In a release earlier this week, the firm warned that if the July or August futures contracts were to settle below US$10 on any day, “the risk of termination of the forward agreements by the counterparties would increase substantially.”

Horizons also warned that the ETFs would be unable to obtain futures exposure if the July or August futures contracts were to settle below zero, as the May crude oil futures contract did last week.

Efforts to halt the spread of Covid-19 have depressed demand for oil. Cancelled flights, shuttered factories and fewer motorists commuting to work have led to oversupply and stretched storage capacity.

Oil prices rebounded somewhat on Wednesday as markets expressed hope that the cautious reopening of certain economies will increase demand, but some observers still worry that the June crude oil futures contract could go negative.

“Volatility in the crude oil market has resulted in a departure of the performance of the two ETFs from their underlying index,” Hawkins said Wednesday. This, Hawkins said, resulted in shares of the funds trading at a substantial premium to their net asset value.

“We strongly discourage new investors in these ETFs right now. If they want to make a bet on oil, there are other products out there that are not Horizons products that they can use to do so.”

If the funds were forced to liquidate their underlying exposure to the futures contracts, the counterparties would unwind their forward exposure at 2:30 p.m. on that day and the fund would go to cash, Hawkins said.

With the ETFs now positioned in the September futures contract, Hawkins said he believes the funds can work with the counterparties and continue to run.

The funds won’t reopen for subscriptions until volatility in the crude oil futures markets “returns to some normalcy,” he said.

“We are hopeful that can happen at some point in time in the near future.”

The Investment Industry Regulatory Organization of Canada issued new guidance earlier this week focused on dealers’ sales practices when recommending leveraged and inverse ETFs to retail investors.

Hawkins said Horizons was communicating with the regulators.