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WisdomTree writes on roll yields


In the second part of the two-part series by Nick Leung, research analyst at WisdomTree, on roll yields, he warns ‘Don’t let roll yield erode your commodity returns.’

Seasonality is a key driver for curve-optimised strategies, Leung says.

“The futures curve for natural gas carries a distinct cyclical profile underpinned by seasonal demand and supply dynamics such as surging demand in winter driving price expectations higher. The predictable premium in futures contracts, over certain points in the year, creates opportunities for dynamic rolling strategies to exploit, with significant implications for investors’ returns.
“A front-month futures strategy will typically be positioned at the front of the futures curve. Given the shape of the curve, the periodic rolling of expiring contracts into more expensive near-month contracts would incur negative roll yield, a drag on returns that would be amplified by the steepness of the curve over time.

“By comparison, an optimised strategy would be holding further out futures such as Feb 17 contracts, denoted by the green dots. This would not only avoid negative roll yield entirely but in fact capture positive roll yield from positioning on backwardated sections of the futures curve. Continuously positioning around these seasonal patterns allows dynamic rolling strategies to materially outperform front-month strategies. Taking a look at natural gas in 2016, a dynamic rolling strategy would have returned 35 per cent, against spot price increases of 59 per cent and front-month rolling returns of just 10 per cent.”
Leung finds that the implications for investors is that since seasonality is a characteristic shared by a wide spectrum of commodities, including agriculture and gasoline, fine-tuning forward curve positioning through a broad optimised commodity strategy can help investors capture additional returns and/or adapt to unpredictable seasonal elements across a variety of commodity exposures. The particularly volatile nature of seasonal commodities is also dampened by positioning further along the futures curve.
“As a result, the prospect of lower volatility coupled with superior roll yield management offered by optimised commodity strategies is, in our opinion, a unique investment proposition that could enhance strategic investors’ portfolios."

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