French banking behemoth BNP Paribas has become the latest financial institution to jump into the ETF industry, rolling out an exchange-traded commodity product this week. The new STREAM S&P Dynamic Roll Global Commodities Fund (BNPC) will seek to replicate the S&P GSCI Dynamic Roll Excess Return Index, a broad-based index of commodity futures that uses a flexible methodology to tilt the portfolio depending on prevailing market conditions. Like many commodity ETPs now on the market, BNPC will strive to maximize the yield from rolling futures contracts in backwardated markets and minimize the adverse impact of the roll process when futures markets are contangoed.
In seeking to achieve this objective, BNPC will generally oscillate between near-dated futures contracts and longer-dated contracts. When markets are contangoed, the index will generally consist of longer-dated futures, thereby minimizing the roll frequency and hopefully the adverse impact associated with that process. For commodities with backwardated futures markets, BNPC will hold primarily front-month futures contracts.
Because contango is generally most severe at the short end of the maturity curve, seeking exposure to longer-dated contracts may be an effective way to mitigate the "roll yield" incurred. Conversely, when markets are backwardated, it may make sense to roll as frequently as possible to pick up additional return in the process.
The following image, taken from the BNPC prospectus, illustrates this concept quite nicely. When futures markets are contangoed, the "roll cost" is often much lower at the long end of the maturity curve. In other words, it will generally be cheaper to roll from fourth month contracts to fifth month contracts than it will be to roll from expiring contracts to the next month.
Under The Hood
BNPC will hold a portfolio of about two dozen individual commodities, including precious and industrial metals, livestock, and agricultural resources. The underlying portfolio will have a significant energy bias; Crude and Brent Crude will make up about half of assets, with other energy contracts (such as natural gas, heating oil, and gasoline) making up another 20% in total. Among the remaining 30% of the portfolio not allocated to energy, the largest allocations include gold, corn, and wheat.
There are already a couple of ETPs linked to the S&P GSCI Total Return Index, including GSP (an ETN) and GSG (a commodity pool). Those two products have aggregate assets of about $1.2 billion, and GSG is the third largest product in the Commodities ETFdb Category.
|Futures Exchange||Index Commodity||Trading Symbol||Dollar Weight|
|KBT||Kansas City Wheat||KW||0.79%|
|ICE-UK||Brent Crude Oil||LCO||19.23%|
BNPC will be structured as a commodity pool, meaning that any gains recorded will be subject to tax at a rate that is a blend of long term and short term capital gains (about 23%). In addition, investors can expect BNPC to deliver a K-1 each year. Commodity ETNs, on the other hand, are generally reported on a Form 1099.
Dynamic Commodity ETPs
While the "first generation" of commodity ETPs focused largely on front month futures contracts, subsequent additions to the product lineup have sought to diversify exposure along the maturity curve. A number of products now implement "dynamic" allocation techniques that vary exposure based on prevailing market conditions. The PowerShares DB Commodity Index Tracking Fund (DBC), for example, is linked to an "Optimum Yield" index that changes its exact strategy depending on current prices.
iPath maintains a suite of "pure beta" ETNs that are designed to mitigate the adverse effects of contango through a flexible roll schedule. The iPath Pure Beta S&P GSCI Weighted ETN (SBV) offers generally similar exposure to BNPC, and uses a flexible methodology to vary the "roll process" depending on market conditions.
BNPC will charge an expense ratio of 0.65% annually, which falls below the average for the Commodities ETFdb Category.
Disclosure: No positions at time of writing.
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