CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition

26.7 ISSUES IN COMMODITY INDEX DESIGN

There are a number of decisions that need to be made when designing a commodity index. These decisions include weighting and roll methodologies, as well as collateral considerations. Enhanced commodity indices may modify the roll methodology and the choice of contracts traded in the pursuit of higher returns.

26.7.1 Value-Based versus Quantity-Based

Commodity indices can be value-based or quantity-based. A value-based index has fixed component weights. The number of futures contracts in the index changes dynamically to maintain constant weights. A quantity-based index holds a fixed quantity of each commodity, so that the index weights change each day. For example, the S&P 500 stock index is quantity-based, since the number of shares of each company in the index changes only when the index constituents are changed. Conversely, a benchmark that consists of 60% stocks and 40% bonds is value-based.

26.7.2 Total Return versus Excess Return

There are two types of return indices available to investors. A total return index is a fully collateralized investment strategy, with the collateralization generally taking the form of Treasury bills. In a total return index, the overall calculation of the index return includes the cash return from the collateral. Generally, total return indices have returns and risk comparable to stock markets. An excess return index provides returns over cash and is linked to the price movements of a basket of commodity futures ...