Oct 5, 2021
[6 min Read]
This analysis covers all of the bases, when wanting to learn about $DBO (Oil ETF). I believe that having an oil ETF in your portfolio is necessary (although many people might argue that it is “outdated”). I believe this because having this ETF in your portfolio will help you to hedge against inflation/interest rate risk, and it can help to counter-balance some of the other holdings in your portfolio (In this portfolio I am using $DBO to counter-balance $TM - Toyota Motors, which I will explain later). This analysis will cover $DBO's risk metrics (and why it is better than other oil ETFs), an in-depth breakdown of their holdings (and their holdings holdings), macroeconomic factors that will influence the price movements of $DBO, and my general thoughts on it.
$DBO is an ETF that has large holdings of Oil stocks, Treasury Bonds, and Treasury Bond ETF's. Over 92% of their holdings consist of companies in the oil and natural gas industries, and their ETF consists of 28% stocks/ETF's (AGPXX, CLTL), 50% Futures (Light Sweet Crude), and 22% US Treasury Bills (maturities vary from 4 days to 6 months).
$DBO has $507M in net assets, has a YTD return of 46.91%, (that has grown significantly over the past 5 years), and has an annual expense ratio of 0.78%.
ETF Risk Measurements:
The DB Oil fund has a 5-year beta of 1.86, which is quite high. Essentially, this value means that $DBO is 86% more volatile than the overall stock market. Typically, when building portfolios, managers try to minimize their beta value in order to minimize the volatility in the portfolios for their clients. This is important for managers because if a client wants a low-risk portfolio, and the manager has a portfolio with a high beta, the customer may not be able to stomach the volatility and take their portfolio to another institution.
Mean Annual Return:
The DB Oil fund has had 3 year, 5 year, and 10 year mean (average) annual returns of 0.4%, 9%, and -11% respectively. Overall, this is significantly better than the vast majority of Oil ETF's, which is due to the fact that $DBO's holdings consist of roughly 50% Oil Futures and 50% US Treasury Bills.
The DB Oil Fund has a 3-year R2 value of 61%. This means that 61% of the price fluctuations in their ETF can be attributed to movements in the general stock market (a benchmark index). This is good news as it is highly correlated to the stock market (S&P 500), which has proven to be a great long-term investment over the past 74 years.
$DBO has a 3-year Sharpe ratio of 0.25. This measures the excess return an investor receives for taking on the extra volatility for riskier assets. Typically, any value above 1 is considered a good return for the associated volatility. So, with $DBO's Sharpe value being 0.25, which means we are getting a small extra return for the increased volatility that we are taking on. However, considering most Oil ETF's have a negative Sharpe ratio, the DB Oil Fund is one of the better quality ETF's for oil exposure to your portfolio.
ETF Holding Breakdown:
Overall, I find this breakdown to be one of the best in the Oil and Gas ETF industry. This is because $DBO is able to hedge their oil risk very nicely through risk-free securities such as bonds and cash positions. I find this to be favourable because many Oil ETF's have had horrible 5-year performances (with many down 40-60%), however $DBO has managed to return 51% over the past 5 years.
You can find a visual of this breakdown at the end of the article
Macro Economic Factors:
Both OPEC (Organization of Petroleum Exporting Countries) and the IAC (International Energy Agency) have stated that there is currently a growing demand for oil that is not matched by supply and estimate that suppliers need to supply 2M more barrels per day to be at equilibrium with demand. Additionally, they also stated that they think oil producers will need to increase their supply by almost 6M barrels per day to meet the forecasted demand at the end of 2021. Essentially, this just tells us that the demand for oil is starting to pick back up, and that this increased demand may lead to increased oil prices later this year.
Also, as more people are getting vaccinated and countries are starting to open back up, individuals will be demanding more oil to get to/from work, as many workers have been working from home over the course of the pandemic. This individual demand for oil should also be priced in.
Lastly, on May 18th, the IEA stated that there should be no new oil and gas investments after 2021. If this were to happen the supply for oil would decrease or remain stagnant, while the demand for oil will increase (and is expected to increase big time). This will most likely result in an imbalance between the supply of oil (from producers) and the demand for oil (by companies and individuals). Since supply will not be able to increase very much, demand will have to fall in order to have supply and demand levels in equilibrium, and the best way to do this is via a price increase. Said price increase would be beneficial for $DBO as the value of the futures would likely start to increase as well.
Interest Rate Changes:
Currently, the US 10-year Treasury Note (risk free rate) is at 1.476%, which is historically low. This means that over the long term it is likely that we will see this rate rise to about 2.25%. As this rate increases, the price of previously held bonds decrease (due to the fact that people can get better rates, and do not want this bond any more). This can pose a threat to DBO; however, their bond holdings tend to be in the short term, which can shield them from the longer term effects of interest rates.
Unless we see a sudden jump in interest rates, I think that DBO is protected against the risk of a change in interest rates. However, even if the interest rate jumps, the price of oil should move upwards and cancel out the effect of higher interest rates on DBO's bond holdings.
I initially thought to include an oil/energy ETF into this portfolio to mitigate the risk of Toyota Motors ($TM) in my portfolio. This is because as the prices of oil increase, there will be slightly less demand for cars. However, where I lose value on Toyota, I should be able to gain some back through $DBO (as the increase in oil prices will be good for their futures holdings).
After choosing to include an oil ETF I began looking for one that has larger cash/bond holdings to mitigate the risk/dependence on oil. I did this because historically oil ETF's have severely underperformed the S&P 500 in the 3 year, 5 year, and 10 year timeframes, and most of the ETF's have averaged negative yearly returns over the last 10 years. My criteria led me to finding $DBO, which I believe to be one of the best quality oil ETFs in the market, returning 9.3% annually over the past 5 years (compared to the S&P 500 which returned 14.7% in the same timeframe).