Riding The Wave

September 01, 2005

Other Index Issues

Contract Selection

Contract selection-the choice of which futures expiration contracts to own-also has a meaningful influence on the returns of an investment. The accompanying chart shows the performance associated with holding crude oil futures contracts in accordance with the index rules for the SPCI and the GSCI. Over time, the differences can have a significant effect.

Keep in mind that this analysis compares the performance of the contract average prices used for the SPCI and GSCI. It does not take into account the specific index component weights and should not be misinterpreted as such.

Although analysis of this type is out of reach for most investors, they should be aware that issues such as this will influence investment performance. Product developers would have a greater need to perform similar analyses.


Roll Periods

Each index has a stated policy as to how positions are to be rolled into more deferred contracts. The choice of which deferred contract to roll into can also have significant implications for investment performance. An analysis of crude oil data beginning in 1987 reveals the magnitude of these differences. The study looked at rolling from the f ront contract into each of the subsequent deferred contracts, and calculated a return series on the continuous contract. Figure 16 shows a clear advantage to be gained f rom rolling out of the front month and into the 4th month over this time period.

Figure 16

Roll Contract

Overall Return (%)

2

1,446

3

1,140

4

2,048

5

1,323

6

826

7

1,322

8

1,457

9

1,072

10

877

11

935

Source: RTM Management

Double Counting

Some indexe s attempt to compensate for downstre a m use of one commodity in the production or p rocessing of another. For instance, soybeans are the primary ingredient in both bean oil and bean meal. There fore, the amount of soybeans may be reduced to account for the inclusion of the other soy-based constituents. This is another reason to be aware of sector weights across the indexes.

In some instances, the double count adjustment can impact sector weights. For example, the SPCI reweights the amount of corn as a result of its being the main feed component of live cattle, thereby changing the sector weights of grains and livestock.

Figure 17

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