Types of Commodity Investment Strategies
A portfolio manager can use several approaches to make commodity investments. There are three broad approaches: index fund, index-plus strategy, and active long-only strategy. Let’s look at each of these in details.
Index Fund Strategy
A commodity index fund is a fund that invests in financial products linked to a commodity index. Since investing directly in an index is not possible, a portfolio manager can do so by simply investing in an exchange-traded fund, buying/selling futures to replicate index performance, or entering into index swaps with investment banks.
In an index plus strategy, the portfolio manager aims at achieving returns above the index. There are several index plus funds following this strategy in the market. In this strategy, the portfolio manager will achieve superior returns through active management of commodity positions and underlying cash collateral. The common techniques are:
- High collateral return: Aggressively using the cash held as margin collateral.
- Roll management: Varying the timing of futures contract rolls from the benchmark, such as deferring contract rolls to take advantage of pricing differences in forward contracts.
- Rebalancing of portfolio
- Maturity management of futures contracts
Active Long-only Strategy
As the name suggests, in this strategy the portfolio manager maintains active long-only positions in commodities. The long only strategy does not use leverage and moves between cash and commodities based on the returns forecasts. Such a strategy would aim to exploit long-term relative trends of individual commodities.