S&P Unveils Contango-Killing GSCI

January 27, 2011

S&P jumps into contango-killing commodity indexes with a new version of the GSCI.

Standard & Poor’s, one of the world’s biggest index providers, launched a version of its S&P GSCI commodity index that’s designed to reduce the potential negative impact of contango on roll returns, making it the latest benchmark provider to get into one of indexing’s new hotbeds.

Separately, BNP Paribas licensed the new benchmark—the S&P GSCI Dynamic Roll Index—for use in investment products, New York-based Standard & Poor’s said in a press release.

S&P’s offering is the latest index designed to address contango, a situation in the futures market where prices for future delivery are higher than prices for immediate delivery. For example, United States Commodity Funds is using a contango-killing index from SummerHaven in its United States Commodity Index Fund (NYSEArca: USCI) and Invesco PowerShares uses an "optimum yield" roll index in its PowerShares DB Commodity Index Fund (NYSE Arca: DBC).

“The development of the S&P GSCI Dynamic Roll Index is based on market demand for indices that can potentially alleviate the negative impact of rolling into contango and offering lower volatility exposure to the commodity market,” Michael McGlone, senior director of commodity indexing at S&P Indices, said in the press release.

The Dangers Of Contango

The term “contango” is also used to describe an upward-sloping forward curve in futures market prices. Investment returns can be badly hurt when fund managers, needing to maintain exposure, have to buy new contracts that are pricier than the expiring ones they have to replace.

The vagaries of contango came into sharp focus about two years ago in the world of ETFs in connection with the U.S. Oil Fund (NYSEArca: USO). It’s an ETF that provides exposure to so-called nearby crude oil prices on the New York Mercantile Exchange; that is, it owns only the contract that will expire the soonest.

Investors of USO were given a rude reality check as USO badly lagged spot crude prices after the market crash of 2008-2009. Crude oil dipped down to below $40 in the depth of the sell-off before bouncing back smartly ever since. But investors in USO pretty much missed the party as returns were eaten up each time the fund rolled exposure into the next contract.

U.S. Commodity Funds addressed the problem, and a similar one it had with a natural gas ETF, by rolling out the U.S. 12-Month Oil Fund (NYSE Arca: USL), which spreads the crude oil exposure across 12 NYMEX contracts, softening the blow of contango. Matt Hougan wrote about the problem almost two years ago in a blog titled “Don’t Buy USO (Buy USL Instead).”

GSCI Dynamic Roll’s Methodology

The S&P GSCI Dynamic Roll Index seeks to roll into the optimal area of the futures curve to provide superior overall returns in times of contango, with exact exposure depending on the extent of contango, S&P said.

When the futures curve for a given commodity is in a general state of contango, the S&P GSCI Dynamic Roll methodology uses futures contracts months that are further out on the futures curve, with the intention of minimizing the effects of negative roll yields.

Of course, commodities markets aren’t always in contango. So, when the futures curve for a given commodity is in a general state of backwardation—that is, nearby prices are higher than prices in the future—the S&P GSCI Dynamic Roll methodology will achieve exposure by using nearby futures contracts, S&P said.

For details regarding complete eligibility criteria, as well as index calculation guidelines, please visit: www.spgsci.standardandpoors.com.


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