What is USL? (Pros, Cons, and Strategies)

If you're looking to diversify your investments or hedge against inflation and economic downturns, the United States 12 Month Oil Fund LP (USL) could be a valuable addition to your portfolio. Today, we'll explore what USL is, along with its advantages and disadvantages, and discuss some investment strategies to help you make an informed decision.

What is USL?

The United States 12 Month Oil Fund LP, or USL, is an exchange-traded fund (ETF) that aims to track the movements in the price of light, sweet crude oil. Unlike other oil ETFs that may focus on near-term futures contracts, USL spreads its investments across the next 12 months of contracts.

Key Features of USL

• Broad Exposure: USL holds futures contracts for crude oil for each month over the next 12 months, providing exposure to a broad range of contract maturities.
• Investment Objective: The goal of USL is to reflect the daily changes in the price of oil as measured by the near month futures contracts available for oil on the New York Mercantile Exchange (NYMEX).
• Diverse Contract Holdings: By holding contracts across 12 consecutive months, USL aims to mitigate some of the short-term volatility seen in more narrowly focused oil funds.

USL Composition

USL invests in futures contracts of light, sweet crude oil, spread out across the next 12 months. This strategy contrasts with funds that focus on the nearest month futures, which can be extremely volatile and subject to the "roll yield" — the financial gain or loss resulting from rolling a futures contract forward into one with a later maturity. By diversifying their contract holdings, USL attempts to offer a smoother investment experience.

Pros of USL

Reduced Volatility

The structure of USL, holding contracts across 12 months, helps reduce the extreme volatility often seen in commodities markets. While no investment is risk-free, this diversification can provide a more stable performance compared to funds heavily weighted toward near-term contracts.

Hedging Against Inflation

Crude oil prices tend to increase with inflation, making USL a potential hedge against rising prices. As commodities, including oil, usually move inversely to traditional financial markets, USL can help protect your portfolio against inflationary trends.

Liquidity of Futures Markets

USL benefits from the liquidity of the NYMEX oil futures markets, ensuring that it can roll its contracts without significant market impact. This liquidity is essential for maintaining the fund's ability to closely track the commodity's price movements.

Cons of USL

Contango Effects

One of the potential drawbacks of a fund like USL is the effect of contango — a situation where the futures price is higher than the expected future spot price. This can result in negative roll yields as the fund rolls over its contracts each month. Consequently, even if spot oil prices remain stable, the fund's performance might lag due to the cost of maintaining its positions.

Expense Ratio

USL typically has a higher expense ratio compared to more conventional ETFs, reflecting the costs associated with rolling over futures contracts and maintaining diverse positions. Higher expense ratios can erode returns over a long investment horizon.

Market Volatility

While USL mitigates some volatility, it can't eliminate it entirely. The oil market is influenced by geopolitical events, supply and demand dynamics, and macroeconomic factors. Therefore, investing in USL requires a tolerance for market fluctuations.

USL Investment Strategies

Investing in USL can be part of a diversified portfolio strategy, particularly for those looking to gain exposure to the oil market without directly purchasing physical oil or individual energy stocks.

Long-term Investment Strategy

USL can serve as a long-term investment for those seeking exposure to crude oil without the extreme volatility of near-month futures contracts. It is suitable for investors looking to hedge against inflation and diversify their portfolios over a multi-year horizon.

Tactical Allocation

For investors with a more tactical approach, USL offers the opportunity to capitalize on specific commodity market trends. By monitoring global economic indicators and trends in the oil market, investors can leverage USL to take advantage of short to medium-term movements in oil prices.

Hedge Against Market Downturns

Given that commodities often behave differently from traditional stocks and bonds, USL can be used as a hedge against market downturns. Adding a small allocation of USL to your investment mix can provide portfolio stability during economic or geopolitical upheavals.

Rebalancing Strategy

Investors using a rebalancing strategy might include USL to achieve target allocations among various asset classes. Regularly rebalancing the portfolio can help maintain an optimal risk-return profile and potentially enhance long-term returns.

Conclusion

In conclusion, USL offers a unique way to gain exposure to the oil market through a diversified set of futures contracts, reducing some of the volatility associated with commodity investments. While not without its risks and costs, USL can be a valuable component of a diversified portfolio, particularly for those looking to hedge against inflation and market downturns. Always consider consulting with a financial advisor to determine if USL aligns with your investment goals and risk tolerance.