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- Reuters CCI® Total Return Index (1982-2005)

By Raymond T. Murphy

Commodities as an Asset Class

As the world markets continue their evolution toward one global marketplace, the advent of financial futures trading has had much to do with that unification. The popularity of financial futures has removed some of the stigmas and fears that were associated with the perceived rough and tumble world of commodities. Previously, commodity futures were considered too risky for investors looking for the stability associated with a traditionally diversified portfolio. But now, with money managers searching the globe for additional investment opportunities, commodities have fallen under the spotlight. The advantages of asset diversification have uncovered this area of investment as the newest tool which will enable investors to better evaluate their long term exposure to the up and down movements inherent in today's markets. By allocating a portion of their investment dollars to commodities, investors are better able to obtain desirable long term results while at the same time lowering the volatility of their portfolio.

Diversification into commodities allows the portfolio to attain a more balanced inventory of assets. Whether or not high levels of inflation resurface, the allocation of a percentage of investable funds into an asset that will successfully lower the overall volatility of a portfolio, while improving the annual performance, is every investors goal. The counter-cyclic nature of commodities to financial assets makes commodities an ideal asset class to incorporate into a portfolio to achieve a more desirable return scenario. Should inflation remain under control, the commodity portion of a properly allocated portfolio may lag other asset classes, but that lag normally indicates that the other non-commodity assets performed well. This is historically true because low to moderate inflationary periods allow for the stable environment in which traditional financial assets have performed well. In such a case, the commodity allocation would have served its purpose as a counter-cyclic asset to the rest of the portfolio. They also provide a hedge against political instability and natural disasters which may adversely affect existing supply/demand alliances.

The Commodity Research Bureau Index (Reuters CCI) and the Goldman Sachs Commodity Index (GSCI) are currently the only two commodity indexes which have exchange listed futures contracts. The newly formed New York Board of Trade (ICE), in conjunction with Bridge Data and RTM Management, have recently produced a total return calculation based upon the Reuters CCI cash index and is directly related to the New York listed Reuters CCI futures contract. This calculation is referred to as the Reuters CCI Total Return Index (Reuters CCI-TR). Previously any analysis of the Reuters CCI Index could only be done on the level of commodity prices. The information now available will allow investors to analyze the return characteristics of the Reuters CCI Index as well.

A New Total Return Measurement for Commodities

The Reuters CCI Futures Price Index, developed in 1956, is the most well known indicator of overall commodity prices in the world. Its original design had weighted the index heavily towards agricultural commodities. Over the past ten years changes have been made so that the Reuters CCI today is more equally representative of a broad range of commodity prices. Currently, the index is geometrically weighted evenly among 17 arithmetically averaged component commodities. Reuters CCI future and option contracts have been traded on the New York Futures Exchange (a division of the New York Board of Trade) since June 1986. The Reuters CCI futures contract has 6 expiration months per year (Jan-Feb-Apr-Jun-Aug-Nov). All futures and options expire to cash on the same date. One Reuters CCI contract is worth $500 times the price of the index.

As the recognized benchmark for commodity prices, the Reuters CCI plays an important role in the investment strategies of funds both large and small. In the past fund managers based their commodity allocation investment decisions on commodity index prices instead of actual realized returns. It would be hard to fault them on this since overall commodity return information was practically nonexistent. The very nature of commodity future contracts requires them to regularly expire. When this occurs an existing position needs to be continually rolled forward. This is rarely done at the same price. Storage, interest charges, short term supply/demand anomalies are some (certainly not all) of the factors attributing to the difference in price between the near term futures price and a more deferred one.

An example would be carrying a Gold futures position. Gold is a market which trades almost exclusively in contango, which means that near term future contracts trade at a lower price than more deferred future contracts. (Backwardation is the term used when the opposite price structure is present). Let's say you own one April Gold 1999 futures contract at a price of $300.00. This means you control 100 ounces of gold at $300.00 per ounce. The April contract will "expire" on a particular day in April of 1999. In order to maintain your desired position of being long 100 ounces of gold, you decide to roll your futures position forward to a December contract. To do this you need to sell your April contract and buy a December contract. At the time you do this the December future is priced $8.00 above the April future. You now have the same position as before but your price is now $8.00 higher. This $8.00 is not a profit but the carrying cost of maintaining a Gold position that far out into the future. A total return index of holding a passive Gold futures position over time would measure only the dollar return associated with the price movement of Gold. The price of Gold has always been an important factor in many macro economic models, but it is the real dollar return which is the true measure of its utility as an investment.

The Reuters CCI is based on the average price of individual commodities over a six month period of time. When a commodity expired it was simply deleted from the index and whatever effect of this may have had on the index was simply reflected in the price the following day. This is why many times you may see the Reuters CCI moving significantly from its closing price the day before to the next day before any of its components have opened for trading. This is the effect of actual component future contracts being added or deleted to the index. This properly reflects price levels for its component commodities and is therefore useful in gauging commodity price strength or weakness against historical periods. What it does not show are the returns which would have been achieved by a passively held investment using the Reuters CCI. By calculating this return characteristic investment professionals are now able to accurately assess the usability of commodities in their overall investment program. A total return index allows commodities to be examined on an even playing field with other traditional asset classes.

Total Rate of Return

The nature of commodity futures make it difficult to determine the actual long term returns associated with a passive position over long periods of time. A passive long term position needs to be continually rolled in order to avoid expiring contracts. A total return measures the actual dollar return associated with a passive commodity position plus the interest earned on a fully collateralized position. The total rate of return for both the Reuters CCI and the GSCI is determined by three factors: spot yield, roll level, and the collateral yield.

The spot yield is the return associated with the price performance of the index.

The roll yield is the return associated with the continuous rolling of near term commodity contracts to more deferred ones. The levels of these rolls will either involve rolling into a lower priced contract (backwardation) or a more expensive one (contango). The roll yield may be either positive or negative, depending on the prices present during the roll period. The combination of the spot yield and the roll yield make up the continuous contract (GSCI literature refers to this calculation as the "excess return"). The continuous contract is a measurement of the realized return of a passive investment in any commodity based on price movement alone. Adjustments are made to account for the rolling of contracts to more deferred contract months without affecting the actual dollar return of the instrument.

The collateral yield is the interest rate component derived from an unleveraged commodity investment. The total return index for both the Reuters CCI and GSCI is the continuous contract plus interest earned from the uncollateralized position. Each index uses 90 day T-Bill rates for this component of their respective total return results.

Passive opportunities in the Reuters CCI-TR

As Table A below clearly shows, the Reuters CCI-TR is an excellent vehicle for diversifying into commodities. The return and volatility characteristics allow it to serve as an ideal benchmark for institutions looking to take advantage of this asset class. And while the Reuters CCI-TR has impressive credentials, other factors make it even more attractive for real world investors.

One of the key features of the Reuters CCI is its method of calculation. Because the Reuters CCI is geometrically averaged, the listed Reuters CCI future contracts almost always trade at a discount to their fair value. This is due to the fact that arbitrageurs are able to manage a short Reuters CCI futures position against an equal weighted long component position which is arithmetically weighted. As time passes and depending upon the volatility of the component commodities, the arbitrageurs long component position will outperform the short Reuters CCI position. This mathematical certainty allows the arbitrageurs to sell Reuters CCI futures contracts at a slight discount to their daily calculated value. Informed investors may regularly obtain this price anomaly and therefore increase their overall return by the level of the discount captured. A large institutional investor may find this aspect of using the Reuters CCI particularly attractive. Along with the size of a Reuters CCI futures contract ($100,000 per contract with the index at 200.00), using Reuters CCI futures contracts may seem the most useful of the current commodity benchmarks currently available.

Many investors looking to commodities as a hedge against other held assets are not so much concerned with commodity prices rising but with commodities prices rising quickly. Large upward spikes in commodity prices may send investors scrambling to insulate their portfolio against the possible inflationary ramifications associated with such a move. The comparatively low volatility of the Reuters CCI make using Reuters CCI options a reasonably priced insurance policy.

An institutional investor thinking about using commodities now has a benchmark linked to the premier commodity indicator in the world. A trader willing to spend the required time learning the subtleties of the index will be able to find numerous trading opportunities. Both groups will find the following summary page provided by Bridge to be invaluable in their decision making.

Years Daily Weekly Monthly
1982-2007 View Chart View Chart View Chart
1982-2007 View Chart RJ/CRB vs GSCI Total Return Indexes
2000-2007 View Chart    
1990-1999 View Chart    
1982-1989 View Chart    


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