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Next-generation approach to managing roll costs

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Interview with Nizam Hamid – According to Nizam Hamid, Head of ETF strategy at Lyxor in London, investors taking exposure in the commodities space are looking to move away from first-generation indices, which take a more simplistic approach to managing roll costs, and looking for more sophisticated, next-generation solutions.

Earlier this year, Lyxor duly obliged by launching a range of ‘smart’ commodity ETFs based on its newly created Optimix TR and Momentum TR indexes.

“We use four different roll strategies. The most straightforward roll is static enhancement, which rolls the third nearby with the fourth nearby to minimise the impact of negative roll yield,” explains Hamid.

The second methodology is seasonal enhancement. This rolls once or twice a year and is used for commodities exhibiting seasonal behaviour such as crop periods for grains or climate pressure for energy commodities. Thirdly, dynamic enhancement is used for commodities that exhibit unstable forward curves such as oil and most industrial metals. Finally, there’s roll timing. As Hamid confirms: “The rationale for this is to benefit from standard rolling investors who typically roll positions between the fifth and ninth day.

“We are therefore buying when standard roll investors are selling. Our long positions are then expected to benefit by the upward price pressure of the new positions being put on by standard roll investors.”

The new ETFs give investors exposure to 24 different commodity contracts. One of the main impacts on investors’ exposure is the cost of carry. Optimix TR and Momentum TR look to address this. Says Hamid: What we’re offering through Optimix is a smarter way of managing that carry cost. If you want to own commodities long-term, having four different roll methodologies is a real benefit and investors appreciate that. It’s solving a problem they understand actually exists, and that’s important.”

“When looking at the yield curve, price signals are able to best match what’s been seen in historic pricing and mis-pricing. Having four methodologies, one of which is dynamic, allows you to capture most events driving prices within the commodity space.”

This best-of-breed approach is being met with favour by potential investors, although it is still early days for the Optimix range in terms of building significant AUM. Launched this January, each ETF has about EUR20million in assets. Hamid notes that interest is starting to grow from institutional investors – to whom these products are targeted – such as insurance companies who are looking at developing long-term positions in the commodities complex.

“Clients’ exposure to the broad commodities ETF space is quite negative: they’ve taken out about EUR2billion over the last year and AUM has dropped by about a third. However, the feedback from clients is that when they look to get back that broad commodity exposure the smarter types of indices that we’ve now developed are what they want to invest in.

“We’re quite pleased with the groundwork we’ve made, therefore, in terms of understanding our clients’ needs. I think when people have the view that the commodities cycle will turn they will look at these ETFs as the most cost-effective way of earning that exposure.”

The commodities space, however, has been challenging this year. Most inflows this year have been going to precious metals, in particular gold: precious metal ETPs have attracted EUR7billion of net inflows over the past 12 months.

With that in mind, Hamid says that going forward Lyxor might look to develop something in the gold equities space.

“We’ve seen some interest from clients looking at gold-related stocks on the equity side and it’s an area we are considering.”

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