What’s Wrong With DBA’s Picture?

January 19, 2010

How have DBA's recent composition tweaks affected the fund's recent trajectory?
  • Equities beat futures in 2009
  • How DBA's lineup has changed
  • Why future backwardation isn't a given

 

If you've been following the agricultural sector for any time, you've probably noted the outperformance of the equity-based Market Vectors Agribusiness ETF (NYSE Arca: MOO) over the futures-holding PowerShares DB Agriculture Fund (NYSE: DBA).

In 2009, MOO's 57.2 percent appreciation trounced the 1 percent gain attained by the PowerShares portfolio. The gains have continued into the new year; last week, MOO racked up a 7.8 percent gain against DBA's 1.7 percent increase.

 

Relative Strength: MOO Over DBA

Relative Strength: MOO Over DBA

 

 There are a number of reasons for the disparate performance. First of all, you'll find the same kind of leverage in agribusiness stocks as you'll find in gold mining shares: Increases in goods' market prices above production costs tend to flow directly to a company's bottom line, regardless of whether it's soybean oil, seed corn or fertilizer. Futures traders have to rely upon margin to leverage their gains (and losses).

Then, too, there's the matter of contango, the bugaboo of commodity index investors. Contango is unique to the futures market and erodes the return of a long position rolled continuously over time. Stocks, as open-ended investments, don't suffer contango.

Even though the Deutsche Bank Liquid Commodity Index-Diversified Agriculture Excess Return—the benchmark tracked by DBA—utilizes an optimized roll methodology to minimize the negative yield in a contango, it can't eliminate it altogether. The index methodology can only make the best of a bad situation.

The DB agricultural index originally provided for expiring long positions to be rolled into a contract for delivery in the subsequent 13 months that would generate the best implied roll yield—the one that's most positive or the least negative.

Recent changes in the index's composition, however, reduced its contango-battling power. In October 2009, DBA's underlying index composition was expanded from six commodities to 11. With that move, DBA took on a sort of split personality. Five commodities—corn, soybeans, sugar, Chicago wheat and Kansas City wheat—were designated to employ the optimized roll strategy, while the other six components—feeder cattle, live cattle, lean hogs, cocoa, coffee and cotton—were designated to use a predefined rolling schedule for contract selection.

When, for example, the March contracts are set to expire, DBA's corn position will be rolled into the lowest-priced futures in the horizon that encompasses the May, July, September and December 2010 contracts, as well as the March 2011 delivery. However, for cotton, there will only be one roll option for the expiring March position—the May 2010 contract.

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