FSS Warns Investors on Commodity ETFs and ETNs: Watch for Tracking Errors and Negative Compounding Effects

This year, amid heightened geopolitical risks in the Middle East leading to increased volatility in energy commodities such as crude oil and natural gas, as well as precious metals like gold and silver, the Financial Supervisory Service issued a notice advising caution to investors in commodity Exchange-Traded Funds (ETFs) and Exchange-Traded Notes (ETNs).

The Financial Supervisory Service noted that many commodity ETFs and ETNs have high tracking errors, and therefore require careful attention from investors. Due to the influx of short-term speculative capital into these products, imbalances in supply and demand can result in significant tracking errors.

Over the past three months, the proportion of commodity ETFs and ETNs with a tracking error of 5% or higher accounted for 32.8% of all commodity ETFs and ETNs. In particular, 68.2% of crude oil ETFs and ETNs and 66.7% of silver ETFs and ETNs recorded tracking errors of at least 5%. The tracking error indicates the difference between the market price and the actual net asset value; when the tracking error is positive (+), it means the market price is overvalued relative to the actual price.

This phenomenon occurs because commodity prices are affected by a variety of factors, including international conflicts and transportation routes. Especially with unresolved geopolitical risks in the international commodity markets, the potential for increased price volatility remains.

Commodity ETFs and ETNs also display high volatility due to the proportion of leveraged and inverse products. Even if the price of the underlying commodity asset merely fluctuates up and down, a negative compounding effect may cause the cumulative return to fall below the return of the underlying asset.

Most importantly, if sharp price swings cause the price of a commodity ETF or ETN to fall below 10 million won, it could be subject to delisting. In particular, ETFs and ETNs issued since 2021 include a clause that mandates early liquidation if their price drops below 10 million won. For products issued after 2021, if the price becomes very small, failure to manage tracking error may also lead to delisting.

An official from the Financial Supervisory Service stated, “We will continue to monitor abnormalities such as trading volumes and tracking errors in commodity ETFs and ETNs, and will issue additional consumer alerts if increased volatility in commodity prices or worsening geopolitical risks further expand investor risks.”

This content was produced with the assistance of AI translation services.