Commodities: Exploring a Constant Maturity Approach
KRISTEN CAPUANO: Welcome, I am Kristen Capuano, Head of Active Product at VanEck. And we’re here today to talk about commodities. VanEck has spent considerable time and resources over the last several decades researching the commodity markets and developing funds that we believe offer the best exposure to these markets. We offer a wide variety of mutual funds and exchange-traded funds that basically cover the real asset spectrum. And we’re here today to talk about one such fund, the CM Commodity Index Fund. And here to discuss the fund with me today is Roland Morris, Commodity Strategist. Roly, thank you so much for joining us. So, CM Commodity Index Fund, what does “CM” mean?
ROLAND MORRIS: Constant Maturity. CM is the constant maturity index1and really that has to do with the structure of the fund and how it invests across the commodities. One thing that’s really unique about the fund is that it rolls its exposure every day across the maturity spectrum. A couple of things that this is really an advantage for: it reduces the negative roll that has been built into the curves, the commodity curves which have been in contango for many years now.
MORRIS: Contango, yes. Instead of backwardated,3they’re in contango, which means the curve slopes up this way, and when you have to roll your exposure, you’re paying a higher price for that exposure. The constant maturity approach does a very, very good job of reducing that negative roll by maintaining that exposure over a longer duration. Another major advantage is that, because it maintains that constant maturity approach (it rolls its exposure every day), it doesn’t get gamed in the roll the way many index products do. I think it’s a very big advantage for this product and it definitely, over time, has reduced that negative roll yield4considerably.
CAPUANO: So, in summary, I believe that a lot of the competing funds, particularly the older funds, invest in what’s called the front month contract,5is that correct? There are, I think, two ways that the CM Commodity Index Fund is different: The first is not front month contracts and the second is a constant roll, is that correct?
MORRIS: That’s correct, it does own some exposure in the front months. Its average duration though is quite a bit longer than those products.
CAPUANO: Okay, understood. What else, then, besides that concept of constant maturity makes the fund unique in your view?
MORRIS: I am a big fan of how it selects its exposure. It uses, actually, GDP and economic consumption numbers to decide how much to invest in the different sectors. In my mind that’s a smart way to invest. Additionally, it has two net effects versus some of the major indices out there. It ends up with more exposure to industrial metals, which happens to be a sector that, as a commodity strategist, I’m very excited about. The demand drivers for that sector look really exciting, between alternative energy, wind, solar, and electric vehicles. That’s one aspect. The other aspect is that it ends up with less natural gas exposure. To me that’s been important, and will continue to be important, because natural gas is a commodity that we have an abundance of and looks trapped to me for a long period of time. It also is a commodity that has a lot of contango in its curve. So I’m a big fan of how it picks its exposure, and I think that’s one of its advantages, as well as the constant maturity approach.
CAPUANO: I know that some funds take an investment view with their collateral. Does this fund do that?
MORRIS: It does not and I’m also a fan of that.
MORRIS: Because there are certain times when commodities actually start moving and you have inflationary expectations building into the economy. The duration that some other fundsꟷduration exposure and credit exposure that other funds takeꟷcould work to hurt returns. We’re simply investing in T-bills, three- and six-month T-bills basically, which is risk-free return. Now that return actually has come up from zero. It’s more like 1.75-2% and that is starting to help these products as well.
CAPUANO: So it’s a commodity fund and you get commodities?
MORRIS: Yes. You do not have exposures that you’re unaware of. We actually, with this product, have made a very good attempt at, and this product does a very good job of, isolating the commodity exposure. We’re reducing that negative roll yield. We’re not taking risk with collateral. And we’re providing the investor with exposure to the commodity movementꟷisolated. I think it’s a very, very good choice for people that are looking to have that passive exposure.
CAPUANO: Perfect. Thank you. Let’s switch over to the commodity markets a little bit now. In addition to your role as Portfolio Manager of the CM Commodity Index Fund, you’re also a Commodity Strategist and you speak with our hard assets investment team a lot and we know that the commodity cycle seemed to really bottom in early 2016 and it’s rebounded somewhat since. What, in your view, are the drivers of that?
MORRIS: I do really believe in cyclicality and the commodity cycle, to me, identified that first quarter of ‘16 as a bottom. That’s when the bear market ended. What happened during the bear market is that we had commodities that were oversupplied and investment in production collapsed. That set the stage for what I believe will be a cyclical bull market. These bull markets tend to last 5-7 years. I think we could be approaching the sweet spot or the heart of the bull market for commodities. What sets that stage is those oversupplied markets. As investment collapses and production collapses, you end up balancing those markets. By the first half of 2016, markets were starting to begin to be balanced. Now we’re entering a period where markets, the tightness of supply, are starting to hold. We’re in markets where the actual supply is going to get stretched and that includes important sectors like diversified mining, industrial metals globally, and energy markets. They’re back in balance and we’re entering a period of time where supply will be challenged. That’s what drives commodity bull markets.
CAPUANO: A lot of investors have seen the recent weakness and might be disenchanted with the asset class. What would you say to those investors and do you believe that this recent weakness is an opportunity to invest now?
MORRIS: I am concerned with the price action. We have actually pulled back further than I anticipated in any type of correction. The drivers currently on the short term are really a strengthening dollar. We had a year of a weakening dollar and the dollar has rebounded this year. That rebound is really being driven by concerns about global trade. The risks of trade war, or trade friction globally, particularly with China, is driving that concern. I understand that, but I really believe this is an opportunity. This pullback represents really good value in many sectors to me. I think the markets are pricing the worst outcome for this potential trade friction. I’m actually a believer that this cycle will last several more years, 3-5 years, and that this is a great opportunity price-wise to enter. I also think it’s important for portfolios to have this type of diversification because we are entering a more normal inflationary environment. The chance for inflation to actually take hold is probably the best it’s been in a decade and there’s no better place to get that protection than commodity products. This is a great way to do that.
CAPUANO: Roly, thank you. To subscribe to more market commentaries from VanEck’s portfolio managers and investment teams, please visit vaneck.com/subscribe.
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1The UBS Bloomberg Constant Maturity Commodity Index (CMCI) is a Total Return rules-based composite benchmark index diversified across 29 commodity components from within five sectors, specifically energy, precious metals, industrial metals, agricultural and livestock.
2"Contango" refers to an upward sloping term structure, in which indices that hold front-month contracts will incur a cost each time contracts expire and must be rolled to more expensive, longer-dated contracts. As contracts move closer to expiration, their value converges with spot prices. So, “contango cost” usually is measured by the difference between spot prices and front-month futures.
3"Backwardation" is the opposite of contango, and refers to a downward sloping term structure. Backwardation tends to occur in contracts and during periods when traders are concerned about scarcity of supplies. Thus, traders would rather have commodities in-hand now (spot) than in the future, and will pay for the privilege. ”Backwardated” means being in a state of backwardation.
4Roll yield is the amount of return generated during periods of backwardation, while negative roll yield refers to the amount of return lost during periods of contango. Roll yield is calculated as equal to [(1+Excess Return)/(1+Spot Return)] - 1.
5A “front month contract” is a futures contract with an expiration date closest to the current date.
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