Dow Jones Index product attacks contango effect

August 7, 2011 07:00 PM


New Index Designed to Mitigate Effects of Contango on Index Performance

NEW YORK (August 8, 2011) – Dow Jones Indexes, a leading global index provider, and UBS Investment Bank today announced the launch of the Dow Jones-UBS Roll Select Commodity Index, a gauge that aims to mitigate the negative effects of contango on index returns.

For each commodity, the new index -- a version of the Dow Jones-UBS Commodity Index series -- rolls from the expiring futures contract into the contract showing the least contango (or greatest backwardation), selecting from those specified contracts with nine months or fewer until expiration. By contrast, the Dow Jones-UBS Commodity Index rolls on a predetermined schedule into specified futures contracts, typically the ones with “nearby” expirations.

When the prices for exchange-traded futures contracts are higher in the distant delivery months than in the nearer delivery months, the market is said to be in “contango”. For example, the sale of a January contract would take place at a price that is lower than the purchase price of a March contract. Holding other factors constant, contango generally has a negative impact on index returns, as the higher longer-term future prices move lower over time to the shorter-term prices. This potential convergence over time is often referred to as a negative “roll yield”.

With commodities becoming an increasingly popular component in investor portfolios, the DJ-UBS Commodity Index family has grown into one of the most popular commodity benchmarks with more than $80 billion in assets under management tracking the indexes, as of June 30, 2011.

“The DJ-UBS Roll Select Index builds upon that popularity,” said Michael A. Petronella, President, Dow Jones Indexes. “With an enhancement that attempts to address the problematic effects of contango on index performance, the new index is designed to roll into contracts that result in the highest annualized roll yield relative to the current contract.”

Except for the above-described determination of the roll contracts, the Dow Jones-UBS Roll Select Commodity Index is calculated according to the methodology described in the Dow Jones-UBS Commodity Index Handbook.

The Dow Jones-UBS Commodity Index is composed of futures contracts on physical commodities. It currently includes 19 commodity futures in seven sectors. The weightings of the commodities are calculated in accordance with rules that ensure that the relative proportion of each of the underlying individual commodities reflects its global economic significance and market liquidity. No single commodity can comprise less than 2% or more than 15% of the index, and no sector can represent more than 33% of the index (as of the annual reweightings of the components). The Dow Jones-UBS Commodity Index is reweighted and rebalanced annually on a price-percentage basis.

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