ETF Securities has written a note on how to mitigate the cost of contango, explaining that an investor in commodities using futures contracts is not only exposed to the price of the raw material but also to the cost of holding a futures contract and rolling it from one contract to another.
The firm writes that to mitigate the cost of rolling (contango), investors need to add exposure to futures contracts with a longer shelf life where volatility is lower but expected return is also less.
Since 2002, ETF Securities says, a portfolio of both short and long maturity contracts outperformed short maturity only contracts by 6.5 per cent per year, enhancing the Sharpe ratio to 0.26.
The mechanism of contango and backwardation continues to intrigue. While contango is known to reduce an investment’s overall return, questions remain as to whether it is possible to avoid it.
Their new note focuses on oil and particularly Brent, looking at the different elements investors should be aware of before considering investing in commodities as well as how to mitigate the negative impact of contango on the performance of a portfolio.