• iShares tracks the Dow Jones AIG index
• Lyxor the RJ/CRB
• EasyETF the S&P GSCI
• ABN Amro Market Access the Rogers International Commodity Index
• DB x-trackers one version of the Deutsche Bank Liquid Commodities Index

Quite how varied these indexes are is shown, for example, by the energy sector weighting, which is 70% in the S&P GSCI, 55% in the DBLCI, 39% in the RJ/CRB and 33% in the Dow Jones-AIG**.

Of course the divergence in the performance between the different versions of commodity index is not only a function of different component weightings, but also reflects the rules adopted for rolling individual commodity futures contracts, since the roll return (positive in the case of a commodity term structure in backwardation, negative in the case of contango) has historically formed a major part of the investor's total income, and the prevalence of contango in recent years has meant a strong headwind for commodity index investors.

While the intricacies of contango and backwardation are beyond the scope of this article (an excellent explanation is given in Deutsche Bank's guide to commodity indexes), two differing approaches amongst European product providers to dealing with the roll return conundrum are worthy of mention.

First, ETF Securities, by launching a whole range of 3-month-forward commodity ETCs last year to complement the existing spot products, has enabled investors to do it themselves and choose which part of the term structure they wish to be exposed to. While this is undoubtedly the realm of the sophisticated investor, they have attracted over 100 million euros into the forward funds since launch.

Second, DB x-trackers has chosen as its sole (to date) European commodity offering an ETF using a methodology that aims to maximize roll yield by choosing from any of the next 13 months' futures contracts when conducting the roll, according to a predetermined formula. On a backtested basis, this methodology has handsomely outperformed the S&P GSCI and Dow Jones AIG indexes. The recent launch of a forward version of the S&P GSCI index shows that others are thinking along the same lines, although to date there is no ETF in Europe based on this.

All in all, this is a complex area for investors to grapple with, and explaining the pros and cons of their differing versions of the commodity indexes presents a major challenge to the ETF houses.

Product Providers 

I noted in my second article for Index Universe the exponential growth in assets of ETF Securities during 2007, a trend that has continued into 2008. From the table above, it is involved in five funds, including four of the top five (three in its own name and the fourth via Gold Bullion Securities Ltd., in which ETF Securities has a 33% share), and the firm has established itself very rapidly as the market leader in the commodity tracker sector.

Its chosen route of entry to the market—decomposing the commodities market into its constituent parts and allowing investors to pick and choose among them—seems very sensible, and the recent addition of inverse funds offers the firm extra tools to attract investors, should the commodity bull run go into reverse.

If the firm has an Achilles' heel, it is the counterparty risk inherent in the note structure it uses—with the exception of its precious metals ETCs, which are backed by allocated metal, investors in its products take the counterparty risk of Shell for energy ETCs and AIG for the others. Although both firms currently carry AA ratings, AIG's recent losses and the announcement of accounting problems have raised fears of a downgrade, and any concerns over the firm's financial strength might inhibit flows into the ETCs concerned.

Amongst the other ETF providers—and all the major European names are represented in the diversified commodity index ETF tables—none has really taken a lead, with most houses running funds in the euros 100-200 million range. Will anyone follow ETF Securities down the single-commodity route? Or will they all continue to search for the perfect index? Expect another busy year for commodity ETF product developers!

* Source - Deutsche Bank, ETF Liquidity Trends, April 15, 2008

** Source - Deutsche Bank Guide to Commodity Indices, July 2007

Paul Amery is the European correspondent for IndexUniverse.com. He can be reached at This e-mail address is being protected from spambots. You need JavaScript enabled to view it .

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