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Commodity index

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A commodity index is a fixed-weight index of selected commodity prices, which may be spot or deffered (i.e. long dated) futures prices. It is designed to be representative of the returns afforded by the broad commodity asset class or a specific subset of commodities, such as energy or metals.

Commodity Indices are usually quoted in percentage of their inception value and exist in three main forms:

  • Price Index or "Spot return", where the index provides an idea of the price level of a commodity basket on a weighted average basis,
  • Excess Return, where the index provides a measure of uncollateralised commodity (spot or forward, depending on the definition of the each index) prices,
  • Total Return, where the index provides a measure of collateralised commodity prices. Total return indices is the only comparable measure of returns with other assets classes (equities, bonds, etc.).


The constituents in a commodity index can be broadly grouped into the following five categories:

  • Energy (Crude oil, Heating oil, Natural Gas,...),
  • Industrial or Base Metals (Copper, Aluminium,...),
  • Precious Metals (Gold, Silver, Platinum,...),
  • Agriculture (Grains such as Corn and Wheat, Oilseeds and "Softs" commodities such as Sugar and Cotton),
  • Livestock (live cattle, ..)


Commodity Indices can be usually classified as Passive or Active. Passive indices achieve the represent the entire asset class without the operation of tactical changes in weightings, roll mechanism or forward curve positioning (tenor). Weightings are usually the result of a well articulated weighting engine using notions such as global economic data, production, consumption data potentially blended with liquidity and open interest (data provided directly by commodity exchanges). Large Institutional Investors mostly choose to gain passive exposure to commodity indices through total return swaps, while retail investor can get access to these new instruments via securitised notes and/or structured products. The advantages of a passive commodity index exposure include negative correlation with other asset classes such as equities and bonds, as well as protection against inflation. For certain indices and/or commodities, the disadvantages can include negative roll yield (carry) due to steep contango), especially for those indices primarily exposed to front contracts only.

When an index operates deviations from the framework defined above (weights, roll, tenor), they can be usually classified as Active. A number of index providers/sponsors aim to achieve roll yield/cost mitigation via algorithmic/curve hunting allocation while others promote active management techniques (such as reducing the target weights of certain constituents, e.g. precious and base metals). The ultimate generation of commodity indexes provide intelligent exposure to the entire forward curve and not just the front segment of commodity forward price curves (the so-called spot contracts).


Indices (see Bloomberg page CRR <go> for a complete list)

Articles

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