The idea of finding the ultimate broad commodity index may be attractive, but it’s too good and simple to be true. However, there are nuances to consider and the right solution may differ depending on individual investors’ preferences.
A way in which commodity indices differ from each other is by their rolling methodology. Buying physical commodities is not an option in the case of a broad commodity basket. So, broad commodity investing involves the purchase of futures contracts, with the expectation of selling a (shorter-term) contract to someone else before it expires and buying another (longer-term) futures contract – this process is what is known as rolling over the contract.
Another important aspect to consider when selecting a commodity index is the selection of sectors. While most of broad commodity indexes will include the same five major commodity sectors (Energy, Industrial Metals, Precious Metals, Agriculture and Livestock), there are small nuances in terms of which component is included within each sector.
Once the sectors have been defined, investors also have to choose the weighting methodology. All these factors have an impact on the risk-return characteristics of the index and therefore must be carefully taken into consideration.
Read more on commodity indexes in our latest On-Track-Research publication.
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