The ComStage ETF Commerzbank Commodity ex-Agriculture EW Index provides investors with broad-basket commodity exposure across the most economically significant commodity sectors minus agriculture. In contrast to most of its peers, this product is based on an equal weighted index rather than using production-based or liquidity-based weighting criteria. This methodology results in an index that places less emphasis on the energy and agriculture sectors and favours the industrial and precious metals relative to its peer group. Consequently, the investor can expect this ETF to experience less volatility than some of its more concentrated, energy-centric cohorts.
Historically, broad-basket commodity futures exposure has been an excellent source of portfolio diversification, demonstrating low correlations with traditional asset classes, like equities and fixed income. These low correlations have traditionally reduced portfolio volatility and increased risk-adjusted returns. In recent years, however, investors have seen these correlations begin to rise with respect to equities. Despite this rise in correlation, commodity futures can still be utilised as a hedge against unexpected inflation and furthermore, unexpected inflation has historically driven positive returns for the broad commodity space. To capitalise on this asset class properly, an investor may, therefore, consider a broad-basket commodity futures allocation to hedge against inflation.
Broad-basket commodity exposure has traditionally been sought out by investors for its diversification and inflation-hedging benefits. Historically, commodities have exhibited low to negative correlations with equities and fixed income securities. In recent years, however, commodities’ correlations with equities have been rising. Increased correlation implies that the asset class’s touted diversification benefits may not be applicable anymore, and that a portfolio’s risk-adjusted returns may not be enhanced by a commodity allocation.
Since 2005, the trailing 5 year average correlation between the S&P GSCI index and the MSCI World and STOXX Europe 600 has been trending higher, from -10% (2002-2007) to 70% (2007-2012) across both indices. Over this timeframe, rising correlations to equities have pervaded the majority of broad commodity indices. Over this timeframe, rising correlations to equities have pervaded the majority of broad commodity indices. While this increase in correlation may seem surprising, this phenomenon has actually been demonstrated in other previously hard-to-reach asset classes, like REITS, and has been labeled trading commonality by James Xiong of Ibbotson Associates. Increased investor interest and capital inflows into historically inaccessible or illiquid markets--such as REITs or commodities--have in part led to these instruments’ progressively higher correlation with equity markets.
But commodities have not lost all of their investment appeal. The case remains that commodities have maintained low to negative correlations with fixed income securities and have continued to demonstrate their value as an inflation hedge. In fact, unexpected inflation has reliably accompanied positive broad basket commodity index returns since 1970. Regressing the returns of the S&P GSCI index against unexpected inflation (defined as year over year changes in inflation rates and measured by the US CPI) yields a statistically significant result, indicating that unexpected inflation explains a portion of the performance of broad commodity indices. This property makes commodities a valuable tool for those seeking to hedge against inflation.
Commerzbank constructs the Commodity ex-Agriculture EW index by dividing the commodity space into four equally weighted sectors: energy, precious metals, and industrial metals. Within the sectors, twelve commodities are chosen to represent an equal 8.33% stake. Commerzbank will rebalance to these weights semi-annually. Due to the equal weighting structure, the index will be less susceptible to the movements in the energy sector than other broad-basket commodity products. The S&P GSCI, in particular, dwarfs the Commerzbank index’s 33% energy exposure with energy sector exposure of approximately 69%. Not surprisingly, therefore, S&P GSCI has been heavily correlated (~94%) with the energy sector over the past five years as represented by the DJ-UBS Energy index. On the other hand, an equal-weighted commodity index on average preserves medium to high levels of correlation (~60-80%) with each commodity sector. Equal-weighted indices tend to have lower volatility than their more concentrated production-, volume-, or market cap-weighted peers.
The ComStage ETF Commerzbank Commodity ex-Agriculture EW employs synthetic replication to deliver the index’s return to investors. It uses an unfunded swap with parent company Commerzbank (A2, A, A+) being the sole counterparty. In this structure, ComStage buys a basket of securities from Commerzbank and enters into an arrangement in which the bank pays the index performance (net of fees) in exchange for the performance of the fund’s holdings. The fund’s holdings are comprised of blue-chip European equities (usually constituents of the EURO STOXX 50 or DAX 30 indices). Since the entirety of the basket’s assets trade in the same or similar time zones as the ETF, overlapping trading hours will reduce liquidity risk if a liquidation of the basket is necessary. The substitute basket is held in a segregated account at BNP Paribas and monitored daily by ComStage’s management company. In addition to the substitute basket, Commerzbank posts collateral equivalent to 105% of the swap value. The collateral basket is held in a segregated, pledged account managed by Clearstream Banking. ComStage will reset swaps three to four times per year and whenever there is a creation/redemption in the fund. ComStage may engage in securities lending, and can loan up to 100% of its substitute basket. In order to mitigate the resulting counterparty risk ComStage requires borrowers to post collateral equivalent to 100% of the loan amount. ComStage accepts government bonds from Germany, the UK, and/or France to be used as collateral.
Investors have an abundance of choices when it comes to broad-basket commodity futures ETPs. The key differentiating factor amongst them will be index construction. Due to differences in index construction, the variety of broad-basket ETPs will not necessarily perform similarly. In considering differences of index construction, an investor will want to focus on these indices sector exposure and rolling methodology. Historically, more evenly weighted (as measured by sector concentration) indices and those utilizing “intelligent” rolling practices have generated superior performance and lower volatility relative to more concentrated indices that use more standard rolling practices.
db X-trackers DBLCI OY Balanced has addressed the dynamic nature of the commodity futures curves by employing an optimum yield methodology, which seeks to generate maximum implied roll yield. The db X-trackers ETF charges a TER of 0.55%.