LGIM launches multi-strategy commodities ETF

Jul 12th, 2021 | By | Category: Commodities

Legal & General Investment Management (LGIM) has launched a new ETF providing diversified exposure to the commodities futures market while using various smart rolling mechanisms to target the most effective contract maturity for each underlying commodity.

LGIM launches multi-strategy commodities ETF

LGIM has launched a new broad basket commodity ETF that seeks enhanced returns through smart rolling mechanisms.

The L&G Multi-Strategy Enhanced Commodities UCITS ETF has listed on London Stock Exchange in US dollars (ENCO LN) and pound sterling (ENCG LN).

According to LGIM, the fund is targeted at professional investors who are evaluating the strategic role of commodity futures as part of a multi-asset portfolio including diversification and inflation protection.

It is linked to the Barclays Backwardation Tilt Multi-Strategy Capped Total Return Index which targets the same commodity allocations as the Bloomberg Commodity Index, a widely followed benchmark comprising futures contracts for 23 commodities across five major commodity groups.

As of the beginning of 2021, the target weights for these five commodity groups were: energy (30.0%), agriculture (30.0%), precious metals (19.0%), industrial metals (15.5%), and livestock (5.5%).

The Bloomberg Commodity Index gains its exposure to all underlying commodities via the nearest dated (or front-month) futures contract. This strategy has its limitations, however, especially in markets with steep contango curves (where the forward price of the front-month contract is trading well above the spot price). As the forward price rolls down to the spot price, this forces investors to suffer a significant negative roll yield as they sell their cheaper, expiring contracts to buy more expensive ones.

The fund’s index aims to overcome this limitation by employing smart rolling mechanisms (based on seasonal, roll yield, or momentum strategies) that seek to target the most appropriate contract maturity for a specific commodity.

The seasonal strategy is applied to commodities such as heating oil, gasoil, and natural gas which have historically exhibited strong seasonality and underlying futures contracts that are highly liquid at certain points in the year. The index will target these commodities at key points during their production and demand cycles where supply and demand dynamics systematically affect prices.

The roll yield strategy is applied to industrial metals as well as the rest of the energy group commodities. For such commodities, the index shall locate the position on the commodity futures curve with the most favourable implied roll yield. Generally, in contango markets, the mechanism will invest further down the curve in longer-dated contracts where the contango effect is usually less pronounced – the curve is flatter and hence the roll returns less negative over time.

The momentum strategy is applied to agriculture and livestock commodities which have historically been strongly influenced by crop and breeding cycles as well as exogenous factors such as weather. The index shall target the futures contract which has exhibited the highest historical annual outperformance over the front-month futures contract.

No enhancement is applied for precious metals such as gold and silver – the index obtains exposure to these commodities through front-month futures contracts.

Howie Li, Head of ETFs at LGIM, commented: “This launch reflects LGIM’s continued commitment to active index design and is another example of innovation where investment strategies can be constructed to focus on the potential for stronger returns, rather than traditional benchmark returns.

“With the track record of one of our other commodities ETFs, we’ve proven that longer-dated futures help with long-term performance and drawdown management by reducing the volatility caused by near-term futures investments. Through risk mitigation and a deep understanding of the return drivers in the commodities markets, we’re aiming to deliver greater value for clients. This investment strategy considers the risks and opportunities associated with the seasonality of certain commodities investments, roll yield enhancements in managing futures, and the momentum effect of certain agricultural investments.”

In addition to the spot and roll returns associated with the futures contracts, the index will also earn a yield reflecting the interest earned on collateral needed to settle the contracts at future delivery dates.

The ETF comes with an expense ratio of 0.30%.

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