Commodities: Uncertain futures contracts (part two)


Commodity indices have a three-digit rate of return. But the slight differences in performance are indicators of their potential volatility.

Most of the time, experienced investors take back testing validations with a grain of salt. Indeed, there is always a bias due to the freedom of choice of the data used. Kolts from S&P is one of the skeptics: “If I have to build a new index, I will carry out back testing which would ensure an optimal roll yield schedule”. Nelson says: “We use all the market futures maturities, and don’t pick and choose them.”

Clearly there will be significant differences between the way E-Tracs and other commodity trackers behave. According to back test results using data from July 19, 1998 through February 29, 2008, UBS’s Bloomberg Constant Maturity Commodity Index has recorded an annual rate of return of 20.2% over the past 10 years. Compared to the 14.3% of the S&P GSCI index and the 13.4% of the Dow Jones AIG Commodity Index (DJAIG), the two most popular indices, the UBS index would have done as well, with less volatility.


A significant part of the performance gap is the roll yield and two other factors that go with it: contango and backwardation. We will take an example to explain these specific terms. Let’s say you have a 1 month oil future maturing in August which is quoted at $100. Now you want to renew it to a $100 contract that expires in September, but this one costs $110. You lose $10 the moment you buy the September future. When this happens – when the prices of contracts with longer maturities are higher than those of shorter maturities – the contract is said to be “in contango”. The reverse can also be true, of course. The August contract could be at $110 and the September contract at $100. So you earn $10 when you buy the September contract.

What leads to these two scenarios? Many factors influence anticipated oil prices. Among them, there may be the weight of the 200 billion dollars of investment in commodity trackers which simultaneously offer contract purchase prices every month. Competition can drive up prices. This makes the development of strategies more expensive for the funds and therefore reduces the returns. S&P’s Kolts believes the market is big enough to handle these flows without affecting prices too much. However, UBS’s Nelson said: “I think it’s important to note that it was when a lot of money started flowing into the DJAIG and GSCI indices in 2005 that their performance decline began significantly. “.

UBS thinks it can outperform its peers by buying long-term contracts over several months – avoiding the rush. This also makes it possible to renew these futures every day to ensure a smooth transition to contracts with longer maturities. Older indices generally move to the next future once a month over a five-day period.

UBS is not alone in using a new strategy with its commodity tracker. Deutsche Bank has developed trackers and certificates on trackers that use what it calls an “optimal return” strategy. “Beyond an automatic monthly rollover by next month’s future, Deutsche Bank’s fund is looking at a much wider range of contracts that cover the next 13 months,” says Kevin Rich, managing director of investment products. at Deutsche Bank. They calculate the best nominal return potential – much like choosing higher yielding bonds. As with UBS’s products, back testing of Deutsche indices indicates that it beats its competitors hands down.

But the markets have a particular way of pacing things. Take the United State Oil tracker, mentioned earlier. It invests in shorter-term futures and is already better than Power Shares DB Oil, which uses Deutsche Bank’s optimal return strategy. While Deutsche Bank’s index back testing showed that its performance almost doubled that of its peers, a change in the shape of the futures curve last year negated its strategy. Anyway, with triple-digit rates of return, nobody cares – not yet.

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