Multi-alpha strategies dominate commodity index developments

Banks are developing combined index strategies that allow investors to access a broader range of trading styles to maximise alpha

Combining uncorrelated strategies into one to extract value

Some banks are turning to enhanced alpha strategies that aim to outperform traditional commodity benchmarks by combining uncorrelated investment strategies.

"Enhanced indexes are a very big trend," says Marc Pantic, head of cross asset solutions at Société Générale Index in Paris. "Benchmark indexes have recently shown some poor performances, especially because of contango in the commodity market, and that has led first-generation indexes to underperform compared to the commodities they should track. A lot of non-specialists came to the commodities side looking to diversify their beta. Now what's really interesting is that you have the same approach but [focused] on the alpha."

The bank's approach revolves around designing multi-alpha strategies on a specific asset class that are not correlated to each other and allow investors to be long the enhanced index and short the benchmark index.

Using its SGI Smart Market Neutral commodity index and SGI Curve Momentum index, for example, the aim is to extract value by diversifying between alphas. "[Both indexes] provide a good Sharpe ratio and analytics, and when you combine them you magnify their alpha because they also show very low correlation one with another," says Alexandre Cosquer, head of commodities investors and global markets at Société Générale in Paris. "You can really add value on two levels: at the strategy level and at the combination level," he says.

"The value of the SGI Smart Market Neutral index comes from the fact that we're invested on different parts of the curve on the long and the short leg. That's the engine that creates value. In the case of the SGI Curve Momentum index, we are in the weight-tilting universe. We choose the commodities that are long and those that are short based on the relative shapes of commodities forward curves. The two indexes use different signals and are not correlated."

At JP Morgan, combining three largely uncorrelated investment strategies into one allows the bank to deliver a range of trading styles to investors. The bank's 3C Index, which is a long-short rules-based commodity index, seeks to generate absolute returns under different market conditions and aims to take more than curve positioning into account.

"The potential to extract value from the forward curve is a form of alpha that is very well understood, and there are a variety of techniques to extract that value and create bespoke combinations of different types of curve alpha," says Tim Owens, managing director and head of commodities investor solutions at JP Morgan in London. "Investors are now looking for approaches that use a range of different trading styles designed to complement each other."

The 3C Index combines a macro strategy that looks at factors such as inflation and currency movements along with a hedge fund-style technical strategy and a combinator strategy based on seasonal trends.

"Our latest strategy is a portfolio of absolute return strategies, each individually looking to extract value from different aspects of the commodity market. The 3C product is less focused on curve positioning and much more focused on extracting value from commodities in a similar manner to the way a hedge fund or CTA would look at the market," says Owens.

"It provides the client with exposure to a multi-style investment strategy that seeks to deliver a portfolio of different trading strategies, each of which lend themselves to different market conditions. Different trading styles are beneficial at different points in time, and a portfolio of trading styles can give better risk-return characteristics."