1. Many commodity funds are set up as “limited partnerships” with pass-through taxation, and the K-1 is the associated tax form.
2. BCOM determines the weightings of constituents based on liquidity and US dollar-weighted production data subject to single and group commodity-exposure constraints.
3. See the appendix for each commodity’s specific roll schedule.
4. In this article, we include UK Natural Gas. In recent years, the liquidity of Dutch Natural Gas has eclipsed that of UK Natural Gas. However, we focus on UK Natural Gas due to data availability and higher liquidity in past years.
5. In this section, we remove the four industrial metal commodities (Aluminum, Copper, Nickel, and Lead) and our PLUS commodity (Tin) from these numbers. Due to data limitations, we measure capacity and tradability with data from other sources. While we are confident in the liquidity of all five assets, the data is not apples-to-apples with the other assets and was removed for interpretability.
6. JPX Rubber, Oats, and Rough Rice are not included in PLUS as they do not meet our capacity criterion. (Investors with smaller portfolios can also consider including these commodities in their universe.) Milk, Cheese, and Butter, on the other hand, failed to meet both our capacity and tradability criteria.
7. Asset volatilities are estimated with historical daily returns using a one-year window and six-month half-life, taking the max volatility of trailing 1.5 years.
8. Attentive readers will notice the full period difference in average returns is not quite statistically significant, though it is over the last 10 years.
9. The outperformance of our Liquid equal-volatility portfolio relative to BCOM is around 3% per annum over the past 25 years, which is consistent with the performance difference between the “inverse volatility” portfolio and BCOM from 2006 to 2019 shown in Ghia, Kartik, Zarvan Khambatta, and Michael K. Donat, “Commodity Investment Insight: Sector Characteristics.” Bloomberg, November 6, 2019.
10. The exposure constraints follow Asset Allowable Portfolio Exposure discussed previously, with a 30% cap to address portfolio concentration concerns for liquid commodities. Consistent with BCOM’s methodology, this limits the exposure of one single instrument to 15% of the entire portfolio. The exposure change constraints are half of the exposure constraints, representing at most 10% (i.e., > 90% haircut) of each instrument’s capacity to control market impact. For the purpose of this article, we assume the constraints are static and apply them across the entire backtesting period.
11. Trading costs include transaction cost (occurs on exposure change) and roll cost (occurs on contract rolling). Both costs are estimated with bid-ask spread, approximately 2x tick size of a futures contract.
12. The cumulative return contribution over the past 25 years is –0.58%, which is close to 0.
13. In fact, if we remove UK Natural Gas, the average volatility-adjusted roll yields for the remaining PLUS commodities are 3.5%, 3.3%, 15.7%, and 16.9% for ITD, 10-year, five-year, and three-year windows, respectively, all of which are positive and far exceed the average volatility-adjusted roll yields of the liquid commodities.
14. Gross leverage across portfolios remains constant.
15. Buying assets that have declined in relative value and selling assets that have appreciated in relative value.