S&P Dow Jones Indices, a leading index provider, recently unveiled the S&P GSCI Risk Weight, an index measuring the performance of the broad-based S&P GSCI commodities index on a risk-weighted basis.
The index takes into account the contribution of each commodity sector to the overall index risk in order to avoid concentration in any one sector and build the most diversified index in terms of individual sector risk contributions.
The five sectors in the S&P GSCI Risk Weight – energy, industrial metals, precious metals, agriculture, and livestock – are the same as the sectors in the parent S&P GSCI.
The risk contribution from each sector is calculated using its covariance, as defined by its volatility and correlation with other sectors. In order to avoid concentration risk, the maximum sector weight is capped at 33% and any excess is redistributed to the remaining sectors based on their risk contribution. The index also seeks to minimise the variance of the risk contributions from all of the commodity sectors.
Jodie Gunzberg, Head of Commodity Indices at S&P Dow Jones Indices, said: “The S&P GSCI Risk Weight allows us to measure the commodities beta provided by the S&P GSCI with a focus on a balanced risk contribution from each sector. This index facilitates access to broad-based commodities with a modified weighting scheme centred on risk and serves as a benchmark to risk based strategies.”
The ideas behind the index appear similar to that of the SmartIX Equal Risk Contribution (ERC) concept developed by Lyxor.
Lyxor’s ERC approach enables the calculation of a portfolio, where constituent weightings are not a function of market capitalisation but a function of their contribution to the overall portfolio risk, as measured by portfolio volatility. In the ERC portfolio, the contribution of each constituent to overall portfolio risk is equalised, avoiding concentration in specific risk and building the most diversified portfolio in terms of individual risk contributions. As a result in the Equal Risk Contribution (ERC) portfolio, the weight of a stock decreases as its volatility or its correlation to other constituents increases and vice versa.
The launch of the S&P GSCI Risk Weight expands the widely followed S&P GSCI family, which comprises several sub-indices including commodity sectors, single components, as well as thematic baskets such as Biofuel and Petroleum.
The S&P GSCI was the first major investible commodity index and is one of the most widely recognised commodities benchmarks. It is calculated primarily on a world production weighted basis and is composed of the principal physical commodities that are the subject of active, liquid futures markets.
The weight of each commodity in the index is determined by the average quantity of production as per the last five years of available data. The production weights are designed to reflect the relative significance of each of the constituent commodities in the world economy while preserving the tradability of the index.