dx-North America’s CIO says identifying future contract with best implied annual roll yield gives investors most benefit.
All commodity indexes are not the same. But what are the differences between the S&P Goldman Sachs Commodity Index, the Reuters/Jefferies Commodity Index, the Dow Jones – UBS Commodity Index, the Rogers International Commodity Index, the UBS Bloomberg CMCI Index and the Deutsche Bank Liquid Commodity Index? Hard Assets Investor continues its ongoing series examining how the major commodity indexes work by interviewing the people and discussing the strategies behind them. In this installment, Managing Editor Drew Voros spoke with Martin Kremenstein, chief investment officer of db-X North America, which is responsible for the Deutsche Bank Liquid Commodity Index.
Previous "Behind the Index" interviews: McGlone: S&P GSCI Index Purest Measure Of Commodity Markets; Carroll: UBS-Bloomberg Index Offers Commodity Curve Diversification; Kowalik: Dow Jones–UBS Commodity Index Offers Broad Diversification, Uniform Distribution; Jim Rogers: Rogers International Commodity Index’s Construction Fuels Its Outperformance
Hard Assets Investor: What would you say is the main difference between the Deutsche Bank Liquid Commodity Index and the other major indexes?
Martin Kremenstein: When you’re getting your returns from commodities, your returns come from three different places. They come from the spot return of the underlying. They come from the collateral return, because when you invest in futures, you do not invest all your capital, so you invest in government Treasury bills as collateral. And then finally, the roll return. It’s on the roll that we differ. The Deutsche Bank Commodity Index rolls according to a formula rather than simply rolling month to month. The formula seeks to achieve the best roll return possible given the curve shape at the time of the roll.
HAI: Can you please explain that formula?
Kremenstein: When it’s time to roll the future, the formula looks at the curve generated by the next 12 futures and it chooses the future with the best implied annual roll yield. Simply speaking, if the curve is backwardated, it’s likely to roll to the next month out. Because the curve tends to be steepest at the front, the aim is to pick up the most benefit most often.
If the curve is in contango, you’re more likely to roll the futures position further out. If, however, there is an anomaly in the curve, and there’s part of a curve that’s cheaper and offers a better roll yield somewhere between front and back, the formula will choose that future.
HAI: Please explain the philosophy behind the index’s commodities.
Kremenstein: We have 14 commodities. The index’s weighting is a combination of production and market liquidity. If you do production alone, you end up with something that’s really dominated by energy. We wanted an index that responds to moves in other markets. We took some of the energy exposure and moved it into agriculture and base metals and weighted them by the tradability of the markets.
HAI: What’s the breakdown by sectors?
Kremenstein: The breakdown is 55 percent energy; 10 percent precious metals; 12.5 percent base metals; and 22.5 percent agriculture.
HAI: How often is the index rebalanced?
Kremenstein: Annually in November.
HAI: What is the crude component?
Kremenstein: We have two crude components: West Texas Intermediate (WTI) and Brent Crude. They are each 12 3/8 percent.
HAI: Why the equal weighting? Do you feel that they’re equals?
Kremenstein: Sometimes people believe Brent is more indicative, and sometimes people believe West Texas Intermediate is more indicative. In our index, we have 55 percent in energy. And of that, 5.5 percent is in natural gas. And then we have 12 3/8 in equal shares for West Texas Crude and Brent Crude, heating oil and automobile gasoline.