CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition

26.6 SOURCES OF COMMODITY INDEX RETURNS

Commodity indices can benefit from multiple sources of returns, many of which tend to be uncorrelated. These can include spot, roll, beta, momentum, rebalancing, and collateral returns. Additional factors, like diversification, commodity component weighting, and roll schedule, can also impact the index return. We now proceed to explain these return sources.

Commodity beta: For a given market, commodity beta can be defined as the return to holding the active futures contract until the contract roll date, and then rolling to the next active futures contract. With respect to liquidity and transparency, this is the simplest way to hold commodities, and thus is the benchmark against which other methods of holding commodity futures are measured.

Roll return: Roll return, or roll yield, is the profit or loss from holding a futures contract due to the change in the basis. Roll returns have a direct impact on index performance. Roll returns tend to be positive when the commodity forward curve persistently slopes down (backwardation), and tend to be negative when the forward curve persistently slopes up (contango). Some commodities, such as gold, nearly always have a negative roll yield. The cost of carry for gold has been larger than the convenience yield, so the forward curve has been upward sloping. The weighting scheme of an index can have a significant impact on its roll return. Difficult-to-store commodities are more likely to be in backwardation, ...