Wednesday, June 17, 2015

Beta, enhanced, and strategy - what works in the commodity world?



The choices for investors in the commodity field is getting crowded as the market has moved beyond simple long-only passive indices. A quick search of Bloomberg shows beta, enhanced, and strategy index categories that are all employed in the commodity space. You can track 69 different indices including 24 beta, 16 enhanced, and 29 strategies.

The beta indices are long-only combinations of commodity futures that mainly vary by market weight and contract maturities. These allow for differences in market exposures and roll yields. The beta portfolios range from the well-established indices such as the GSCI and Bloomberg to indices that are focused on alternative weightings or holding longer maturity contracts. These are beta indices in the sense that they should move up and down with the overall commodity market. There could be a strong argument that there is no clear definition of beta in commodities, but we will let that pass.

The enhanced indices try and take into some specific commodity patterns within futures markets such as backwardation and contango. The focus in backwardation or spreads create lower volatility portfolios that attempt to have returns less correlated with the overall direction of the market.

The strategy indices will be active portfolios that generate return through rules-based management that can be replicated as an index. The can include momentum weighting, roll weightings, and be long-only, long/short, or market neutral

The table above shows the high and low return for each index category by year as well as the range. We have color-coded the high and low returns each year with the best category being green, the worst red and the middle blue. This will help show what will be the max gain or loss across all index categories.  There clearly is a large range within any strategy. The gap between picking the best and worst index in a given year can be upwards of 20 percent for the beta portfolio. It is actually wider for the strategy indices which try and exploit repeatable events. The enhanced indices show the tightest range but even in this category there is double digit differences.

The commodity space is clearly uncertain with no order in performance. Strategies will do the best in any year and they will also be the worst within the space. Surprisingly, the beta portfolios are not a bad choice in the confusing world. Their low-end generally will not be the worst performer when compared with the other strategy. Gaining commodity exposure is not easy investment decision.

No comments: