Commodities Follow Equity Index Precedent

Chidem Kurdas

Third-generation commodity index funds, using a rules-based approach to set the mix and weightings of individual commodities, are new.  Third-generation indexes may outperform the first generation, exemplified by S&P GSCI, by as much as 10% a year or better.

But the investment record is short. The first such ETF, the US Commodity Index Fund, was launched in August 2010—see interview with United States Commodity Funds chief investment officer John Hyland in Opalesque Futures Intelligence, a publication I edit.  

Third-generation commodity indexes follow the second generation versions, which do better than the older index funds by buying futures contracts further out on the curve, thereby avoiding losses due to contango markets. These have attracted investors.

Mr. Hyland says US Commodity Index Fund is the first in the third generation but in a year there may be half a dozen such products.  

A somewhat similar idea has a track record in the equity world.

Robert Arnott’s Research Affiliates Fundamental Index Methodology uses fundamental factors – sales, cash flow, dividends, book value – to select and weight companies. By contrast, conventional stock indexes weigh companies by market capitalization. How have RAFI funds done in the past decade?

Not bad, it turns out. The FTSE RAFI 1000 made 6.08% annualized in the 10 years as of the beginning of May. By comparison, the cap-weighted Russell 1000 returned 3.34% and the S&P 500 made 2.82%. There’s been criticism that RAFI is not really an index methodology but active management in disguise. That issue pales in view of the long-term track record.

The various RAFIs took time to gain investor acceptance, but contain around $50 billion in assets now.

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One Response to “Commodities Follow Equity Index Precedent”

  1. Managed Futures ETF: the Alpha Question « HedgeFundSmarts Says:

    […] A third-generation commodity index  aims to get the upside of commodity returns while avoiding some of the downside. It’s meant to be a better way to get commodity exposure.  But what does a managed futures index do? I asked Tim that question. […]

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