Innovation has been a hallmark of the ETF industry in recent years, as countless first-to-market products have debuted offering investors new tools for accessing asset classes and investment strategies that were previously hard-to-reach. This has especially been true in the commodity space, where a number of resource-specific funds have begun trading and twists on indexing methodologies have presented new strategies for exposure to the “third asset class.”
United States Commodity Funds, the firm behind several ultra-popular energy products as well as the recently-launched “third generation” commodity ETF has plans to keep the commodity ETF space moving forward. In a recent filing with the SEC, the company provided details on three new exchange-traded products. Each of the proposed funds would follow in the footsteps of USCI, seeking to mitigate the adverse impact of contango by implementing screens to identify commodities in backwardation or exhibiting only mild contango. Contango, which occurs when futures contracts nearing expiration are cheaper than longer-dated contracts, has become a four letter word to some investors, thanks to the potential of this phenomenon to erode returns generated by futures-based products.
The new funds proposed by USCI include:
- United States Agriculture Index Fund: This fund would track the SummerHaven Dynamic Agriculture Index, a benchmark designed to reflect the performance of a diversified group of agricultural commodities. The Agriculture Index consists of fourteen agricultural markets: soybeans, corn, soft red winter wheat, hard red winter wheat, soybean oil, soybean meal, canola, sugar, cocoa, coffee, cotton, live cattle, feeder cattle and lean hogs. Each agricultural commodity is assigned a base weight based on an assessment of market liquidity and the commodity’s overall economic importance. Based on observable price signals (i.e., momentum and the slope of the related futures curve), weightings to these individual commodities will be altered on a monthly basis [see Guide To Agricultural ETFs].
- United States Metal Index Fund: For investors seeking a diversified play on the metals market–including both precious and base metals–this proposed fund could one day make for an interesting option. The index to which this fund would be linked consists of ten metals, including six base metals (aluminum, copper, zinc, nickel, tin, and lead) and four precious metals (gold, silver, platinum, and palladium). Similar to the agricultural index, each metal is assigned a base weight based on an assessment of market liquidity and the metal’s overall economic importance. On a monthly basis, momentum and basis factors will determine whether each metal should be overweighted or underweighted relative to the base allocation of the index [see all the ETFs in the Metals ETFdb Category].
- United States Copper Index Fund: Unlike the two proposed funds highlighted above, USCF’s copper ETF is linked to a single-commodity index. But the underlying benchmark also “attempts to maximize backwardation and minimize contango,” in this case by using different weighting and roll strategies depending on whether or not the copper market is in backwardation or contango [see a Closer Look At Copper ETF Options]. Currently, the underlying index allocates half of its holdings to December 2011 contracts, with the remainder split between March 2011 and April 2011 copper futures.
Following In USCI’s Footsteps
The three proposed products will to some extent, copy the techniques pioneered in the company’s recent launch of the broad-based Commodity Index Fund (USCI). The fund tracks the SummerHaven Dynamic Commodity Index Total Return, which consists of 14 futures contracts selected on a monthly basis for a list of 27 possible contracts. That fund first identifies commodities exhibiting the steepest backwardation or most mild contango, and then fills out holdings based on momentum metrics. USCI is a relatively new fund, but has turned in impressive results in its brief history, outpacing many of the most popular broad-based commodity funds by a wide margin.
The new ETFs proposed by USCF would also utilize “contango screens” and momentum analyses, but not in an attempt to identify commodities that should be included or excluded from the underlying benchmark. Instead, the quantitative analysis based on the work of a group of academics would be used to determine which resources should be overweighted and which should be underweighted–meaning that the indexes will at all times maintain some degree of exposure to each of the constituents [also see A Closer Look At The 'Third Generation" Commodity ETF].
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Disclosure: No positions at time of writing.