|
Page 3 of 4
Building A Better Strategy
Passive strategies that use a momentum-based long/short approach rather than the long-only approach of the most common commodity indexes can better serve investors by attempting to capture the full excess return from a futures strategy. Such passive strategies are also likely to prove a better benchmark for the active strategies of professional futures investors.
To make this idea operational, we created a new family of commodity indexes that includes combinations of long commodity futures, short commodity futures, and cash. The primary index, called the Morningstar Long/Short Commodity Index, holds commodity futures both long and short based on momentum signals. The other indexes are derived from this Long/Short index. The family includes a long/flat version, which holds cash in place of the short positions in the primary version so that investors who do not want or cannot have short positions can still get some benefits of a momentum-based long/short strategy. The family also includes a short/flat version for investors who already have long-only exposure to commodities and want some benefits of the momentum strategy without having to replicate or drop their long-only exposure.
We created a set of single-commodity indexes to serve as constituents for the Long/Short index and the related composite indexes by calculating a "linked" price series that incorporates both price changes and roll yield. The weight of each individual commodity index in each of the composite indexes is the product of two factors: magnitude and the direction of the momentum signal. We initially set the magnitude based on a 12-month average of the dollar-weighted open interest of the commodity. We then cap the top magnitude at 10 percent and redistribute any overage to the magnitudes for the remaining commodities. The direction depends in part on the type of composite index, and as we explain below, in part on the type of commodity in the Long/Short index.
In the Long/Short index each month, if the linked price exceeds its 12-month daily moving average, the index takes a long position in the subsequent month. Conversely, if the linked price is below its 12-month moving average, the index takes the short side. An exception is made for commodities in the energy sector. If the signal for a commodity in the energy sector is short, the weight of that commodity is moved into cash; that is, we take a flat position. Energy is unique in that its price is extremely sensitive to geopolitical events and not necessarily driven purely by demand-supply imbalances.
For the remaining indexes, the direction is set as follows:
- Long-Only—always long for every commodity
- Long/Flat—same long positions as the Long/Short index, replaces the short positions with flat positions
- Short/Flat—same short positions as the Long/Short index, replaces long positions with flat positions
- Short-Only—always short for every commodity
|
