HardAssetsInvestor

Written by Brad Zigler  |

October 05, 2009

Sign Of The Times: Long, Short, Flat In One Index

Details

Can a momentum-based commodity exchange-traded product outperform long-only trackers?

• LSC vs. DJP: ETNs side by side
• Contango’s impact on both
• LSC’s shifting composition

 

Index investors used to be easy to spot. They once wore "long-only" signs around their necks. Recently, though, indexes of all sorts have been created that aren't limited to simple buy-and-hold methodologies. We now have "strategy indexes" that allow for short, long and/or flat positions in a portfolio.

Among these is the S&P/Commodity Trend Indicator (CTI) Index, a composite of 16 commodity futures grouped into six sectors. The index algorithm positions each sector as long, short or flat, based upon its recent price behavior, and uses market momentum vs. a seven-month moving average as the trigger for repositioning.

In particular, the CTI methodology treats two sectors specially—softs and energy. For softs—that is, cotton, sugar, coffee and cocoa—positions are set on an individual commodity basis. For energy, the only exposure options are long or flat; CTI countenances no shorts in petroleum group futures.

Since June 2008, the S&P/CTI has been tracked by the ELEMENTS S&P CTI Exchange-Traded Note (NYSE Arca: LSC), an obligation of AA-/Aa3-rated HSBC.

When we last looked at LSC, it had handily outperformed long-only commodity trackers, such as the iPath Dow Jones-UBS Commodity Index Exchange-Traded Note (NYSE Arca: DJP) over the second half of 2008. By year's end, LSC had gained 6.3%, while DJP had lost 50.1%.

Much of LSC's 2008 outperformance was due to its avoidance of the crude oil market. DJP, on the other hand, had outsized exposure—on the long side—to the historic midyear plunge in energy prices.

 

LSC Performance: 23 June 08 - 31 Dec 08

 

This year, however, LSC's been dragging its tail. Since the top of the year, the momentum-following ETN has given up 11%, while DJP's gained 6.5%. Apparently, buy-and-roll has been the better approach to commodities in 2009.

 

Contango's Effect On Commodities ETNs

Because of contango, DJP's return actually understates the returns that can be earned from buying commodities. (Contango describes a carrying charge market, where commodities destined for later delivery are priced higher than commodities delivered earlier; the price spread mostly reflects storage, insurance and financing costs.) Rolling a long futures position forward in a contango means selling the expiring, near-term delivery at a lower price than it costs to acquire the deferred contract. The cost of rolling eats into the returns garnered by the appreciation in the price of the commodity.

Keep in mind that the roll effect is reflected at the index level. DJP and LSC are exchange-traded notes, not funds, so there's no portfolio directly backing these notes.