Barclays just launched 18 ‘pure beta’ commodities ETNs. But what exactly does ‘pure beta’ mean?

If there’s a truism for commodities investors, it’s that contango kills. Contango—when the futures of a commodity are more expensive than the spot price—hurts futures markets investors, sometimes to the exclusion of any positive gains in the underlying commodities.

Most commodities ETFs use futures contracts to obtain exposure to the underlying commodities. As each futures contract expires, the fund manager must roll the fund’s position into a new contract with a later expiration date. If the price of the new futures contract differs from the expiring one, the investors will either enjoy extra yield (in backwardated commodities) or suffer a loss (in contango commodities).

The new pure beta ETNs from iPath we covered earlier this week attempt to neutralize this “roll yield,” and provide pure(r) exposure to commodity returns.

Instead of automatically rolling its exposure every month into the next near-month contract, each iPath ETN algorithmically chooses one futures contract for each commodity that theoretically will best represent that commodity’s returns.

The indexes the ETNs track first calculate a “proper” value for each commodity, and then create a three-month time series of the weighted average price of the first 12 futures contracts, weighted by the open interest. The model then chooses the futures contract that tracks this price series the closest, subject to liquidity and dislocation filters.

To qualify, a contract must have at least 7 percent of the total open interest and not be “vulnerable to price distortions.” Whether a contract is vulnerable is determined by short-term supply and demand factors, such as severe weather conditions and/or inventory shortages.

Are They Actually Better?

Since historical data for the new iPath ETNs isn’t available, I’ve assumed perfect tracking and compared the broadest of the new products, the iPath Pure Beta S&P GSCI Total Return ETN (NYSEArca: SBV), to the S&P GSCI Index.

As the name of the ETN suggests, its index tracks the same commodities as GSCI, but applies its own methodology to select particular futures contracts. Over the past five years, the index has consistently outperformed the plain-vanilla GSCI.

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