Like most fund managers, real assets investors get measured against a benchmark, and to date, that’s mostly something along the lines of CPI +3% or 5% points, the rationale being that real assets allocations are primarily inflation hedges, and besides, there are no established long-term real assets indices that would be the equivalent of MSCI Emerging Markets in BRIC markets, for instance.
Yet, real assets investments are becoming less about hedging, and more about income generation and capital returns, as natural resources become scarcer. One of the difficulties in capturing this intent in an investment mandate was always that there was no adequate benchmark, nothing that could be considered an industry standard.
Likely inadvertently, Credit Suisse’s commodity team recently began to change this with the introduction of a new commodity exchange traded note (ETN) – Credit Suisse Commodity Rotation ETN (CSCR) – whose underlying index, the snappily titled Credit Suisse Commodity Backwardation Total Return Index, is designed to capture the scarcity of the 24 commodities that comprise the index. Floated on June 11, 2013, the ETN trades under the ticker CSCR and has reached only $24 million in assets thus far. The ticker has the usual benefits of ETNs: no K1s, no tax impact from rebalancing, and no Unrelated Business Taxable Income (UBTI). Its major challenge will be attracting sufficient attention; smaller ETNs have a tendency to be canceled by their sponsors after a while.
The ETN was introduced as part of an overhaul of the company’s broad based commodity index, the Credit Suisse Commodity Benchmark Total Return, which had seen few changes since its original formulation by Bob Greer (now an Executive Vice President at bond firm PIMCO). The index’s primary advantage was its broad base – it includes 34 commodities vs. 19 for the Dow Jones-UBS Commodity Index and 24 for the S&P GSCI index. The newer CSCR index utilizes the 24 commodity sub-sectors of the S&P GSCI index, and adds the more active approach that has become popular among exchange traded fund and ETN providers.
It is a “return seeking index, a rotation exchange traded note with concentrated exposure to physically scarce commodities” according to Credit Suisse. The methodology begins by observing that backwardated commodities – those whose futures price is below their expected spot price – have historically seen positive returns from rolling futures contracts, a way of extending the life of the existing commodity position beyond the expiration of a current contract. Each month, the level of backwardation is calculated, for each of the 24 commodities in the index, by taking the differential between the front and sixth month contracts on the futures curve of each commodity. The 8 commodities with the most backwardation are then equally weighted in the index at 12.5% each. In simple terms, the index contains the 8 commodities that the market views as becoming scarcer over the next six month period. To preclude the index ever distorting trade in a given commodity, there’s a liquidity threshold which ensures that the index will never trade more than 10% of the daily open interest.
With contango (a commodity’s future price exceeds its expected spot price) being more common than backwardation, the Credit Suisse team believes that the greatest returns will come in commodities that are transitioning from being freely available (contango) to scarcer (backwardation).
As one would expect, the index has a slightly negative correlation with bond indices and a slightly positive one – just under 0.5 – with US and emerging market equity ones as well as with the consumer price index (CPI) and oil, though the time periods involved are too short to have sufficient data points as yet:
At a time when asset management firms are seeing ever-greater competition for their funds and services, ever-higher compliance costs, and pressure on fees from ETFs and discount brokerages, product development provides one of the few methods of differentiating themselves from the competition. Consequently, indices such as the one discussed here can only be a positive for the much-needed development of new real assets funds. Given that Credit Suisse is licensing the index methodology for free, it will be as interesting to see what others build on top of the index as it will be to track its progress.