S&P's new GSCI Dynamic Roll index aims to reduce contango, will serve as underlying for notes

By Emma Trincal

New York, Feb. 8 - Standard & Poor's S&P Indices experts are hoping to attract commodity investors seeking to reduce contango in their commodity portfolio with the launch of the S&P GSCI Dynamic Roll index, Michael McGlone, senior director of commodity indexing at S&P Indices, told Prospect News.

The new index should also serve as the basis of future structured products, he added.

"We have licensed the S&P GSCI Roll index to BNP Paribas," McGlone said. "We've been in talks with a number of financial institutions to license the index.

"On the institutional side, there's plenty of demand from pensions or endowments to get exposure to such an index either through a swap, an exchange-traded product or a structured note. This index could certainly be used as the underlying of a structured product."

The S&P GSCI Dynamic Roll index uses the same approach as the S&P GSCI, a widely used commodity benchmark, but its goal is to reduce the potential negative impact of contango on roll returns, said McGlone.

Contango

The market is in contango when the price for future delivery is higher than the price for immediate or nearer delivery. As the roll of a commodity contract consists of selling the nearby contract and buying the contract further out on the curve, the contango creates "negative roll yield," represented by the upward sloping forward curve. This added cost may erode returns.

"A lot of investors are looking for ways to get involved with commodities while reducing the exposure to the potential negative roll yield one can get from contango," McGlone said.

Some commodities are impacted by contango more than others, he said, citing energy as especially problematic but metals as less of a concern.

"When you have contango, the index will measure the contango in the market between each contract and determine where it is the best place to roll," he said.

"Every time it's time to roll a commodities futures contract, the index will take a snapshot of all the futures prices and determine what the spread between each futures contract is."

The way contracts will be rolled each month will depend on whether the futures curve is in contango or in backwardation, which is the opposite of contango.

When the commodity is in contango, the index will use futures contracts that are farther out on the futures curve, McGlone said.

On the other hand, in backwardation, the best contracts to roll into are the nearby contracts.

"The index methodology measures the price between each contract, what's the narrowest spread between the contracts and rolls accordingly," he said. "The goal is to reduce the cost of rolling."

Institutional demand

McGlone said he sees demand for the new index mostly from institutional investors, although retail investors have demonstrated an increasing interest in commodities.

A number of investment banks have already created similar commodity indexes aimed at reducing the negative impact of contango, McGlone said. But S&P may attract more attention as the index provider is an independent third party, he noted.

"We think a pension or an endowment would be interested in a more standardized index created by an independent index provider to be used as a benchmark."

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