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Article / 05 January 2017 at 11:31 GMT

Commodity funds and the annual rebalance — #SaxoStrats

Head of Commodity Strategy / Saxo Bank
Denmark
  • 2016 sees commodity sector return to profitability
  • Index-linked commodity investments see annual 'rebalancing'
  • Rebalancing transactions may prompt market movements

Rebalancing
The annual January rebalancing of commodity funds is always well-anticipated, 
but it can still lead to market movements. Photo: iStock 

By Ole Hansen

Last year the commodity sector returned to profit for the first time since 2010. Positive returns were seen across most sectors apart from grains and livestock. 

Despite maintaining different investment approaches (see below), two of the world's most-tracked commodity indices managed more or less the same return at around 11.5% 

Total return 2016
  
What is a commodity index?

Before moving on, let us just have a look at what a commodity index actually is and how it works. A commodity index either invests in or tracks the performance of a group of commodities based on predefined rules. 

It is often the performance of these indices that is referred to in the media or when comparing commodity performance with other markets, such as stocks and bonds. 

Large investors often prefer a diversified approach, especially to commodities, given the high level of volatility that invariably goes with investing in individual commodities. Commodity index funds help investors to properly benchmark the performance and return of their investments. 

Commodities
After all, a big swing in one individual component 
can have severe knock-on effects... Photo: iStock 

Due to the increased popularity of commodities, these funds have grown in recent years.

Two major indices

The two major indices, as mentioned above – the S&P GSCI index and the Bloomberg Commodity index – have become the industry-standard benchmarks for investors in commodities. 

These two indices have, according to latest data from Morgan Stanley, a large investor following that currently sits at around $115 billion ($55bn GSCI / $60bn BCOM). 

Investors either invest directly into the funds or through exchange-traded funds that track their performances. Furthermore, many local commodity fund offerings track one of the two commodity funds.

Different structures and strategy

The S&P GSCI, established in 1991, is an index calculated primarily on a world production-weighted basis. It comprises 24 physical commodities that are the subject of active, liquid, futures markets. 

The weight of each commodity in this index is determined by the average quantity of production and is designed to reflect the relative significance of each of the included commodities in the world economy. 

Due to this structure, the S&P GSCI is very heavily exposed towards the energy sector, with 56% of the index currently invested in products ranging from crude oil to natural gas.

Allocation
















The Bloomberg Commodity Index (BCOM), previously called the DJ-UBSCI was established in 1998 and has a more diversified approach. This index comprises 22 physical commodities, all represented by active futures markets. 

No single commodity can comprise less than 2% or more than 15% of the index and no group or sector can represent more than 33%. 

The weightings for each commodity included are calculated in accordance with rules designed to ensure that the relative proportion of each of the underlying individual commodities reflects its global economic significance and market liquidity. 

2017 allocation
Individual allocation
 
 
 
 
 






























Different composition, different performance 

Investors looking for passively managed exposure to commodities should therefore be aware of these different allocation structures. The S&P GSCI offers a large exposure to energy while the BCOM offers a bigger exposure to metals, both industrial and precious. 

(Also note that BCOM has an 8% exposure to the very volatile natural gas contract where the notorious contango tends to create a challenge for those seeking a longer-term gains.)

There are of course numerous other commodity indices which also can be traded through ETFs, of which the best known are probably the Reuters-Jeffries CRB Index and the Rogers International Commodity index. 

Impacts of the January rebalancing

Index-linked commodity investments such as the ones that follow the major commodity indices mentioned go through a rebalancing period every year where the index weightings are adjusted. The reason for this process is to align and adjust existing positions according to the individual performances during the previous year. 

Generally, the exercise involves buying/increasing the exposure of commodities which suffered losses during the previous year at the expense of selling/reducing commodities experiencing gains. In addition, the overall target weight of an individual commodity or sector can also be adjusted, while old contracts can be removed or new added. 

The rebalancing for both commodity indices occurs in January during a five-day business period from January 9 to January 13. 

According to calculation carried out by Morgan Stanley, the contracts seeing a significant amount of selling next week will be Brent crude oil, natural gas and sugar. The contracts seeing the most demand will be corn, wheat, live cattle and gold.

Cattle
It's your time to shine. Photo: iStock 

These transactions are well-flagged and known to the market in advance but may still create some movements depending on the available liquidity in the different contracts. 

How to gain access to commodities via ETFs

Below is a list of some of the major US listed ETFs offering access to commodity index (CI) funds. There currently exists more than 100 ETFs on various exchanges which has a broad-based commodity investment approach. 

To find others, please use the search function on your SaxoTraderGO platform.  

Commodity ETFs


— Edited by Michael McKenna

Ole Hansen is head of commodities strategy at Saxo Bank 

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