Rolling Futures Contracts
Most futures contracts are rolled primarily on a monthly basis, but some are rolled less frequently, namely some grains and precious metals. Liquidity of the underlying commodity determines frequency of rolling. The DJ-AIGCI and GSCI have a five-day roll period close to the beginning of the month. Craig Braswell, manager of index operations at Dow Jones, says, "With a five-day roll period, 20% of the holding will be rolled each day over five days. If all contracts are rolled in just one day, this may result in a big adjustment in the market." The SPCI has a slightly shorter roll period of three days. The DJ-AIGCI and GSCI roll their contracts every month whereas SPCI rolls its contract every two months on average.
Roll returns tend to be negative when a futures price is above the expected future spot price, a situation known as "contango," and positive when the futures price is below the expected future spot price, i.e., when the market is in backwardation. The shorter roll-period results in relatively lower roll costs whereas the longer roll process may have a better chance to capture backwardation.
Index Committee Decision-Making
The construction and maintenance of these indexes are handled by committees to ensure their objectivity and consistency, with each committee being comprised of professionals, academics and exchange representatives. All indexes are re-weighted once a year as determined by their committees to reflect current production and/or liquidity data.
The DJ-AIGCI and GSCI committees make rebalancing and re-weighting decisions in June and November, respectively, but defer implementing them until the following January. The SPCI committee makes its decision in November but defers implementing them until the following February. All three index providers have announced their re-weighting decisions for 2004.
Conclusion
In addition to being a proven effective inflation hedge, there is a definite role for direct commodity investment in every investment portfolio. Additional diversification benefits become more achievable in combination with stocks and bonds. Each index demonstrates different characteristics and strengths. With DJ-AIGCI's maximum ceiling on any single commodity class being 33%, it has more room to include other commodities, making it more appropriate when the investment emphasis is on diversification. The GSCI is more pertinent when the focus is on OECD economic growth with a high concentration in energy. If you are striving to achieve low volatility and benefit from commodity exposure at the same time, SPCI seems to an ideal choice for any investment portfolio. In all, bearing a low to negative correlation to stocks and bonds, commodities, bought through direct investment, prove to be a valuable defensive asset class with strategic importance over the long term.
Pauline Lam is a New York City-based consultant and freelance writer specializing in commodity finance and index research. She can be reached at (212) 829-7189 or [email protected].