Dow Jones Indexes has launched a commodity index series that seeks to minimise the contango effect on index performance using a strategy that selects futures contracts exhibiting the least amount of contango The Dow Jones-UBS Roll Select Commodity Index aims to mitigate the effects of contango on index performance by rolling into the futures contracts showing the least amount of contango, or the most backwardation, selecting them from contracts with nine months or fewer until expiration. "Contango has a negative impact on the roll yield," says Jamie Farmer, executive director at Dow Jones Indexes in New York. "When something is in contango as you're rolling, you are selling a cheaper contract and buying a more expensive contract, and each time you do that there's a degradation in the roll yield. The introduction of the Roll Select index is a reflection of the desire to increase the overall opportunity set of the main index and meeting specific market dynamics and client needs." The index is based on the Dow Jones UBS main commodity index, which is composed of 19 commodity futures that span seven sectors. Unlike the Roll Select Commodity Index, each commodity in the main index rolls on a specific pre-determined schedule. "With the roll select methodology, we seek to find the contract to roll into that exhibits the least amount of contango or the most amount of backwardation," says Farmer. "That contract could be anywhere from the next calendar month or next normal roll up to nine months further, selecting from a broader selection pool of expirations and choosing the contract that exhibits the least amount of contango." Enhanced commodity indexes have become increasingly popular among investors seeking exposure to commodities, offering different strategies that aim to reduce the impact of contango on the roll yield, such as using an algorithmic enhancement mechanism. "If you go back in commodity index history, the first generation of indexes was long-only with the weight of the individual components fixed annually," says Harry Tchilinguirian, global head of commodity markets strategy at BNP Paribas in London. "Equally these indexes were statically positioned at the very front of the curve. As such, the negative impact of contango, when present in a commodity, would lead to a greater incidence of the negative roll yield in that commodity's total return. "To mitigate the impact of negative roll-yield, the algorithmic enhancement mechanism in BNP Paribas' indexes seeks to optimise the distribution of a position in a given commodity along its future curve by minimising exposure to where the contango on the curve has the steepest slope, while equally controlling for liquidity constraints in longer dated maturities."...
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