Intelligent Commodity Indexing: A Practical Guide to Investing in Commodities - Rilegato

GREER

Rilegato

ISBN 10: 0071763147 ISBN 13: 9780071763141

Casa editrice: McGraw Hill, 2012

Riassunto

THE SECRETS TO CAPITALIZING ON THE COMMODITIES BOOM

In the mid-1970s, when Bob Greer scrolled through miles of microfilm in the basement of a public library in orderto record commodity prices in his yellow legal pad, the idea of commodities being an investable asset class was way outside the mainstream. Now, it's a multibilliondollarvehicle for achieving portfolio diversification and inflation hedging--and he and his colleagues have written the book on earning better returns than the indexes themselves!

In Intelligent Commodity Indexing, Bob joins his fellow leaders of PIMCO's Commodity Practice, Nic Johnson and Mihir Worah, in opening up commodity indexes. Never before has there been a more thorough explanation of how acommodity index works coupled with a powerful set of strategies for making it work for you. Inside, you'll find the most up-to-date tools and time-proven best practices for earning "structural alpha" by capitalizing on recurring risk and liquidity premiums in the commoditiesmarkets. It offers the right amount of history and theory to reinforce cuttingedge techniques for:

• Interpreting how seasonal effects change risk premia
• Choosing the most profitable market for specific commodity exposure
• Using intelligent commodity indexing to collect risk premiums in the options market
• Maximizing roll yield in order to increase long-term returns
• Managing risk, including specific frameworks and systems

Investors gain a superior advantage with this book's coverage of the nuts-and-bolts workings of various markets.

Praise for Intelligent Commodity Indexing

"A seminal work on an asset class that has grown in importance within institutional portfolios. The authors offer considerable insight to this complex asset class andprovide investors with a thorough examination of the drivers of risk and return." -- Julia K. Bonafede, CFA, President of Wilshire Consulting

"This is an excellent guide for professional investors to successful investing in commodity indexes." -- Blythe Masters, Head of Global Commodities, JP Morgan

"A manual written by successful practitioners for intelligent commodity investors. An excellent guide which explains how this asset class complements and interactswith other investments." -- Alan H. Van Noord, CFA, Chief Investment Officer, Pennsylvania Public School Employees' Retirement System

"Commodities are invaluable tools for investors wishing to benefit from diversification and inflation hedging. For such an investor, this is the authoritative source to all you need to know about commodity indexing." -- Mark Makepeace, Chief Executive, FTSE Group

"Greer, Johnson, and Worah simply explain the critical drivers to commodity index returns that have provided the main historical benefits of diversification and inflation protection. Every commodity index investor, or hopeful investor, should read this book and use it as a guide for evaluating the relevant index characteristicsfor benchmarking and investing, especially given recent industry innovations." -- Jodie Gunzberg, CFA, Director-Commodities, S&P Indexes

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INTELLIGENT COMMODITY INDEXING

A PRACTICAL GUIDE TO INVESTING IN COMMODITIES

By Robert J. Greer, Nic Johnson, Mihir P. Worah

The McGraw-Hill Companies, Inc.

Copyright © 2013 Robert J. Greer, Nic Johnson, and Mihir P. Worah
All rights reserved.

ISBN: 978-0-07-176314-1

Contents

Foreword
Introduction
CHAPTER 1 History of Commodity Indexing
CHAPTER 2 Drivers of Commodity Index Returns
CHAPTER 3 Thinking About Inflation Hedging and Diversification
CHAPTER 4 Intelligent Commodity Indexation Overview
CHAPTER 5 The Drivers of Roll Yield
CHAPTER 6 Maximizing Roll Yield
CHAPTER 7 Calendar Spreads and Seasonal Strategies
CHAPTER 8 Substitution
CHAPTER 9 Volatility
CHAPTER 10 Implementation
CHAPTER 11 Risk Management
CHAPTER 12 Commodity Fundamentals
CHAPTER 13 Index Development—The Next Phase
Conclusion
References
Index

Excerpt

CHAPTER 1

History of Commodity Indexing

There has been an interest in commodity prices, and indexes of those prices, fora very long time. Until the late 1970s, those indexes typically referred toprices of physical commodities. Part of the reason is that the interest incommodity prices stemmed from the impact that commodities had on the overalleconomy, whether in the United States or elsewhere. Commodities were nottypically viewed as an investment vehicle in their own right.

Some of those early indexes were published by Reuters, by the FinancialTimes, by the Economist, and by other data sources. These indexescomprised a broad range of commodities, including commodities for which therewere futures markets as well as commodities that had no futures equivalent.There were, and are, a variety of other indexes of cash commodity prices forspecific industries, including livestock, energy products, and mining products.Both Dow Jones and the Commodity Research Bureau also published indexes thatused the current, or spot, month of commodity futures markets as a surrogate forcash markets, partly because this information was readily available. But likethose other early indexes, these published indexes based on futures prices werenot investable because they could not be replicated by a financial investor.Therefore if investors wanted exposure to commodity prices, they typically wouldpurchase the capital asset that was used to produce thecommodity—farmland, or a metals mine, or an oil and gas partnership, ornatural resources companies. These investments could provide some positiveexposure to commodity prices, but there were drawbacks.

While the most obvious problem was liquidity, an investment in the means ofproducing a commodity also gave exposure to other risks, not all of which wererelated to commodity prices. For instance, the success of a farmland investmentmight depend not just on the price of the food it produced but also on theweather. And the purchase of a natural resources stock exposed the investor tothe financial structure of the company and to the management talent of thecompany. There could also be risks unassociated with the price of the commodity,as investors in BP realized when that company's oil rig exploded in the Gulf ofMexico in 2010. In this case, while oil prices initially spiked higher due tothe loss of production, BP stock actually declined significantly on anticipationof liability and cleanup costs associated with the explosion.

Actually purchasing and storing a commodity in order to benefit from an increasein its price was also typically not practical, with the exception of preciousmetals, for which the storage cost was small relative to the value of theinvestment. Industrial metals might also be purchased and stored for longperiods, but in this case the storage cost was a much higher percentage of theinvestment. Additionally, some agricultural commodities could be purchased andstored for limited periods of time, but that type of investment would sufferfrom spoilage as well as from high costs for storage and insurance. Furthermore,there was not a large incentive to hold commodities in order to benefit fromrising prices, since the prices of many commodities had not even kept up withinflation during the decades following World War II. This was partially theresult of improving technology that enhanced extraction rates for oil and metalsas well as increased yields for grains, resulting in periods when commoditysupply, both actual and potential, was well above demand.

During the inflation and related shortages of several commodities, such asgrains and industrial metals, in the 1970s, however, the interest in commoditiesfor investment began to take root. But still, that interest tended to expressitself in the purchase of the capital assets that actually produced commodities.Although the impact of higher commodity prices on inflation may have been wellunderstood, the possibility of hedging against this via a systematic investmentin a basket of commodity futures was generally not appreciated. Investors weretypically not able to get exposure to anything like a broad-based index ofcommodity prices.

THE FIRST INVESTABLE COMMODITY INDEX

The early 1970s was also a time when investors first saw the idea of aninvestment designed to replicate an index of the stock market. Sure, there hadbeen stock indexes for many, many years, but the first stock index fund was notoffered until the early 1970s. Seeing that commodities were contributing toinflation in the 1970s, and seeing also the appearance of an investable stockindex fund, gave Bob Greer the idea of finding a way for a financial investor togain exposure to commodity prices. At that time, commodities were thought of ashigh-risk investments. But in fact, the price of an individual commodity mayoften be no more volatile than the price of a single stock. The price of wheatwas typically no more volatile than the price of IBM.

There were two reasons why commodities were thought of as being so risky. Thefirst reason was that participants in the commodity futures markets typicallyused a large amount of leverage. This leverage was possible because the marketparticipants did not actually own a physical commodity, which would haverequired borrowed money to finance. Instead, the market participants made acommitment to buy (or sell) a commodity in the future. As long as they closedtheir position before they were contractually obligated to take delivery of (ordeliver) the physical commodity, they only had to deposit sufficient margin toensure that they could perform on that future commitment, adjusting that marginas the price of the future commitment moved for, or against, them. This allowedthe market participants to be exposed to a large notional amount of thecommodity with only a small capital commitment. Hence small adverse movements inthe price of commodities could entirely wipe out the capital of these leveredinvestors, just as small favorable moves might multiply the investors' capitalmanyfold. This margin deposit might be thought of as being similar to theearnest money deposit that is typically made by a buyer of a house when thathouse is put under contract. The full amount of the purchase price is onlyrequired when the sale is consummated. This leads to the second reason thatcommodity investment was misunderstood. Many investors did not understand thevery nature of a futures contract. They equated having a long position in acommodity futures market with outright ownership of the commodity itself.

To take the risk of leverage out of a commodity investment, it was possible tofully collateralize the commodity contract. That is, if a live cattle contract(40,000 pounds) were trading at 50 cents per pound, the notional value of thecontract would be $20,000. Instead of making a minimum margin deposit of, say,$1,000, investors could allocate a full $20,000 of their portfolio to support asingle long contract in cattle. The investors thus would have the capitalactually to purchase the cattle if these investors chose to do so. The notion ofleverage is removed, because no matter how low the price of cattle might fall,the investors would have money to meet any margin call. And the investors' totalreturn would be the return on collateral plus or minus the change in the priceof the futures contract. This idea meant that the investors would always havepositive exposure to a rising cattle price. It also meant that fullcollateralization could only take place with long positions—you can'tdetermine how much collateral would be required to support a short position,since there is no way of knowing the maximum size of a move against you.

This type of investment also had an advantage compared with equities. The priceof the asset could not go to zero; companies can go bankrupt, but cattle can't.Even in the 1956 debacle in the onion futures market, the price of the futurescontract did not go to zero. (It went to 10 cents, which was less than the costof the bags in which the onions were stored.)

Next, Greer had to determine what collateral an investor might use. He chose the90-day bank CD rate, since he wanted to simulate a high-quality investment thattypically had little noticeable interest rate risk. In most modern publishedindexes, the collateral is assumed to be the 30-day T-bill rate (reset weekly),since index providers want to use relatively low-risk collateral that will notunintentionally bring other financial risks into the portfolio. In addition tobeing low risk, T-bills can also be used as margin collateral against theunderlying futures positions that make up the index. Therefore, choosing T-billswould allow the published commodity indexes to be simply replicated. However,investors have found that in an ultralow interest rate era like 2009–2011,T-bills are often thought of not only as the "risk-free" investment but also asvirtually a "return-free" investment. (How investors deal with the selection ofcollateral is discussed in Chapter 10, "Implementation.") Thus we havethe first of what are now understood to be the three defining characteristics ofa commodity index: full collateralization of commodity futures positions toavoid leverage, along with a choice for what this collateral would be.

But what would happen when the commodity futures contract matured? Would thelong-only investors end up taking delivery of a load of cattle? Sure, they hadenough money to pay for it, since they were fully collateralized. But that's notwhat typical investors wanted. This problem could be overcome by rolling theirposition forward before the delivery date. That is, before the first deliveryday for the October contract, the investors would sell the October contract andbuy a December contract. The investors still maintain exposure to the risingprice of cattle, but they would never actually own the cattle. In addition, theywould always be earning interest on their collateral.

With this insight, Greer defined the second of the three definingcharacteristics of a commodity index: there would be well-defined rules forrolling the commodity futures so that investors had continuous exposure to thecommodity markets without actually taking delivery or storing the physicalcommodities.

Investors who were worried about inflation would likely not want exposure onlyto cattle prices. They would want exposure to a broad-based set of commoditiesto get more thorough and diversified price exposure. To get this type ofexposure, the investment process would have to allocate to many commodities thathad sufficiently liquid futures markets, and it would have to be based on somemeasure of relative economic importance, such as relative importance in worldtrade or relative importance in a measure of inflation like the consumer priceindex (CPI).

Indexes today have a variety of ways of determining this relative importance, insome cases using online databases and complicated calculations. But Greer's workwas before the era of personal computers and the Internet, so that the veryconcept of "online" did not exit. However, there were other measures todetermine relative importance, two of which were the CPI published by the U.S.Department of Labor and the Reuters-U.K. price index, which weighted commoditiesbased on their importance in world trade. Greer used these two indexes as themeasure of relative importance. He first determined which commodities wererepresented by available futures contracts. He then lined up all the componentsof the Reuters-U.K. price index and mapped each component onto one of thoseavailable futures contracts. Clearly there was not an active futures market foreach component of the price index, and so some improvisation was required. Greernext did the same thing with the CPI, mapping each component of the CPI againstone of those limited number of available futures contracts. Here even moreimprovisation was required, since there was no clear way that the servicescomponent of the CPI might relate to a commodity like wheat or live hogs. Thefinal step was to take the average of the mapping results for the two indexes toyield weights of an investable commodity index that would total to 100%. Thisresulted in the third criterion needed to define a commodity index: a systematicway to determine the choice of commodities to include and the relative weightsamong them. The first investable commodity index had been created! By"investable," as described in the introduction to this book, we mean that afinancial investor might be able to replicate the returns measured by the index.

Finally, with the index methodology fully defined, Greer calculated historicalresults, from 1960 to 1974 (later extending the returns through 1978). Becausepersonal computers had not yet been invented, the gathering of data and thecalculation of returns were quite laborious. So Greer, after gathering data byhand from microfilmed copies of the Wall Street Journal, chose tocalculate the index returns at six-month intervals. This meant that positionsrolled forward twice a year. And because he assigned a percentage weight to eachcommodity, that first index rebalanced twice a year.

The results were published in the summer 1978 edition of the Journal ofPortfolio Management. Reflecting the purpose of the index, the title of thearticle was "Conservative Commodities: A Key Inflation Hedge." Investableindexes today typically incorporate the principles established by that initialwork. An investable commodity index should reflect the returns from aninvestment process that:

• Reflects the result of holding only long positions and rolling them forwardaccording to specific rules

• Assumes all futures positions are fully collateralized

• Assumes that weighting in some fashion typically reflects the relativeeconomic importance of components

• Follows a transparent and fully specified method of calculation

There was some additional academic research on commodity index investing in the1980s including work by Bodie, Rosansky, and others. But there was virtually noserious investor interest. There was as yet no mechanism, like a commoditymutual fund, that would enable individual investors to get commodity indexexposure. Institutional investors showed little interest, likely because eitherthey did not understand the nature of futures contracts, much less this novelidea of indexing; or they were simply enamored by the stocks in theirportfolios; or they were afraid to venture into an area where no institutionshad yet invested.

THE 1990s

It was only in 1991, 13 years after Greer's pioneering work defining the firstinvestable commodity index, that the industry saw the first commerciallyavailable index supported by a major institution. With great fanfare, GoldmanSachs announced the Goldman Sachs Commodity Index (GSCI), which is currently themost referenced commodity index, with an estimated $100 billion in assetsbenchmarked to it (as of December 31, 2011, estimated by Standard & Poor's). Theprimary motivation for this index creation was to allow investors a potentialway to take advantage of commodity producers selling in the futures markets inorder to hedge their product prices (discussed in Chapter 2, where wetalk about the drivers of return to an index). This investment method would beintended to give investors exposure to commodities as an asset class, whileimproving liquidity in the markets by having a better match between buyers andsellers. Goldman later sold its index business to Standard & Poor's, so thatindex is now known as the S&P GSCI.

In 1993 the influential Frank Russell consulting firm published a white paper byErnie Ankrim and Chris Hensel which explained the potential benefits ofcommodity indexes in an overall portfolio. The GSCI was followed by indexessupported by other investment banks in the 1990s. Bankers Trust began marketingthe Bankers Trust Commodity Index (BTCI). Merrill Lynch began marketing theMerrill Lynch Energy and Metals Index (ENMET). J.P. Morgan started publishingthe JPMorgan Commodity Index (JPMCI). And Daiwa Securities worked with Bob Greerto resurrect his original index, refined to become the Daiwa Physical CommodityIndex (DPCI). These index providers mainly sought institutional investors, whomight enter into OTC swaps to get exposure to their particular index.

Then, in 1998, the industry saw the first vehicle by which individual investorscould get commodity index exposure. The Oppenheimer Funds launched theOppenheimer Real Asset Fund, which was benchmarked to the GSCI and usedstructured notes to get commodity exposure. At about the same time thatOppenheimer was launching its fund, a closed-end fund was launched in the UnitedKingdom to track the GSCI. Oppenheimer's fund is still in existence. However,some of the shareholders of the U.K. closed-end fund forced a liquidation beforethe end of the century since it was trading at a discount to fair value.

There still seemed to be little interest in, or understanding of, commodityindexes. This did not, however, deter AIG from coming to market in 1997 with itsown version of a commodity index, the AIGCI, which is currently the second mostwidely used commodity index, with an estimated $80 billion in assets benchmarkedto it (estimated by Dow Jones as of June 30, 2011). The motivation behind theAIGCI was to construct an index with a weighting methodology that resulted inmore intercommodity diversification than the GSCI had. It also held its positionslightly further out on the forward curve, and it rebalanced once a year, whilethe GSCI never rebalanced based on changes in prices. Later, after aligning withDow Jones as the calculation agent for that index in 1998, AIG renamed the indexthe DJAIGCI. That index was sold to UBS after AIG's downfall, and it is nowoffered as the DJUBSCI. Meanwhile Daiwa sold the DPCI to Chase Manhattan Bank(later merged with J.P. Morgan), where it became first the Chase PhysicalCommodity Index and then the JPMorgan Commodity Futures Index. J.P. Morgan quitcalculating that index in 2000, and Credit Suisse eventually utilized Greer'smethodology to bring to market the Credit Suisse Commodity Benchmark (CSCB)index in 2009. The defining characteristics of these three major commodityindexes are shown in Exhibit 1-1.

(Continues...)

(Continues...)

Excerpted from INTELLIGENT COMMODITY INDEXING by Robert J. Greer. Copyright © 2013 by Robert J. Greer, Nic Johnson, and Mihir P. Worah. Excerpted by permission of The McGraw-Hill Companies, Inc..
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Dettagli dell'edizione

• Editore: McGraw Hill
• Data di pubblicazione: 2012
• Lingua: Inglese
• ISBN 10: 0071763147
• ISBN 13: 9780071763141
• Rilegatura: Copertina rigida
• Numero di pagine: 288
• Contatto del produttore: Messaggerie Libri; ufficio.anagrafiche@meli.it; ; Via Verdi, 8.; Assago Milano; 20090; Italia