DBE: An Energy Futures ETF For The Short-Term (NYSEARCA:DBE)

The Invesco DB Energy Fund (NYSEARCA:DBE) (“the Fund”) is an exchange traded fund (“ETF”) which:

Seeks to track changes, whether positive or negative, in the level of the DBIQ Optimum Yield Energy Index Excess Return™ (DBIQ Opt Yield Energy Index ER or Index) plus the interest income from the Fund’s holdings of primarily US Treasury securities and money market income less the Fund’s expenses. The Fund is designed for investors who want a cost-effective and convenient way to invest in commodity futures.

The Index is a rules-based index composed of futures contracts on some of the most heavily traded energy commodities in the world — light sweet crude oil (WTI), heating oil, Brent crude oil, RBOB gasoline and natural gas. You cannot invest directly in the Index. The Fund and the Index are rebalanced and reconstituted annually in November.

The fund’s index is designed to reduce the effects of contango by selecting futures contracts that, by its rule, have the highest implied roll yield for each commodity. The fund weights commodities by liquidity rather than production and strategically selects futures contracts in an attempt to maximize roll yield. The index underweights WTI and Brent crude relative to our benchmark, while providing extra exposure to Heating Oil, RBOB Gasoline and Natural Gas. Gas oil is completely excluded. Structured as a commodity pool, investors should expect a K-1 at tax time. The fund and the index are rebalanced and reconstituted annually in November.”

As of the end of April, the Fund’s top ten holdings were:

The Fund has about $270 million of Assets Under Management (“AUM”) and an Expense Ratio of 0.75%.

Seeking Alpha has graded its expense ratio as a “D.”

Since inception in early 2007, the total return (“ROR”) has been about 4% through April 2022.

Source: Seeking Alpha.

And it experienced a worst Peak-to-Valley Drawdown (“P2V”) of 85%. I consider the P2V as the most important risk measurement since it reveals how much of the investment could have been lost by an investor at the worst time. If the maximum loss exceeds investors’ risk tolerances, they may exit the investment, locking-in their loss. Generally, investors in hedge funds have the option to terminate their investment before the “lock-up” period if the P2V exceeds 30%.

Over the past year, the Fund has returned 89.2%, as compared to a loss of 0.2% in the SP500TR. The surge in energy prices was clearly beneficial to DBE investors.

Energy Portfolio

As noted above, the Fund is most recently invested in four energy futures contracts:

1. NY Harbor ULSD Future June 22 (“RBOB”) 13.81%;
2. Brent Crude Future July 22 (“Brent”) 10.66%;
3. Crude Oil Dec22 “(WTI”) 9.69%;
4. Henry Hub Natural Gas Apr23 (“NatGas”) 5.43%.

To assess that basket, I first calculated the cumulative monthly returns of each commodity along with DBE going back to February 2007.

I found that the commodities had the following returns:

Source: Boslego Risk Services.

Notes:

1. For the purpose of this analysis, I used the nearby futures contracts, which technically cannot be traded continuously, since they expire and must be “rolled.” I did not calculate brokerage commissions or bid-ask spreads of the rolls.
2. For Brent, I used the spot price, not a futures contract.
3. As indicated in the methodology above, the Index upon which the ETF is based uses a more complex method to choose which futures contract to select for the Index.
4. Because the Index uses deferred futures contracts at times, their risk (P2V) would likely be substantially lower than that of the nearby futures contract or spot price (in the case of Brent).

I also calculated the respective P2Vs. I found each commodity had high P2Vs of 80% to 89%.

Source: Boslego Risk Services.

Next, I calculated the historical returns and P2V of a portfolio consisting of the four commodities listed above with those weights. I found that the ROR for the period was 68%, much higher than DBE’s actual 4%.

I also calculated the P2V of the portfolio with recent commodity weights. The maximum drawdown was 40%, a much better result than DBE, which was 85%.

I therefore conclude that the commodity weights of the Index must have changed over time. However, I could not find a listing of their historical weights online to confirm that.

These findings lead me to investigate whether the commodity weights most recently reported could be improved. For guidance, I calculated the correlations of RORs of the monthly returns (not prices). Except for natural gas, the price series have very high correlations…

Source: Boslego Risk Services.

However, what really matters are the correlations of monthly returns, which are considerably lower, except for WTI v. Brent.

Source: Boslego Risk Services.

Diversification, as measured by correlations of portfolios, leads to lower risk. The best correlations for diversification are negative ones, followed by low positive correlations.

The lowest correlation (15%) was between Nat Gas and Brent, while the highest correlation was between WTI and Brent. That latter correlation suggests one of them could be shorted to give a high negative correlation.

For illustrative purposes, I designed a new portfolio (“New Portfolio”) as shown below. The main difference is a “short” position in WTI more than offset by a longer position in Brent. The resulting ROR and P2V, compared to the DBE history provides a much better return (43%) and far lower maximum P2V (23%).

Source: Boslego Risk Services.

Applying DBE’s current energy commodity weights since inception provides a higher return (68%), but a maximum P2V (40%) which is almost twice as high as the New Portfolio.

I also graphed the historical ROR of the New Portfolio v. actual DBE. As can be observed, the New Portfolio did not experience the massive losses of DBE.

Finally, I recently reviewed The United States 12 Month Oil Fund® LP (NYSEARCA:USL) here and The United States 12 Month Natural Gas Fund, LP (NYSEARCA:UNL) here. I referred to my algorithmic trading strategy (the “BRS” strategy) in the first of those articles or oil. Based on the latest update, as of the close of May 31^st, it is still providing a long signal, which is supportive of a net long position in WTI, RBOB and Brent combined.

In my article about UNL, I concluded that it was undervalued in the short-term, though it may become overvalued over the next month or two. And so that is supportive of a short-term long Nat Gas position.

Conclusions

The share price history of DBE shows an excessive maximum drawdown and not enough return to justify a long-term position. The New Portfolio demonstrated how risk (P2V) could be reduced by changing the portfolio weights. But the long-term ROR was also too low to justify a long-term “Hold.”

DBE has performed well over the past year, however, and net long positions in the energy commodities are justified. Therefore, I conclude that it is a “Hold” for the short-term.

Finally, if an investor who trades futures contracts wants to hold a portfolio of futures contracts, they should consider the New Portfolio presented above. It demonstrates a much lower risk of drawdown than DBE.