S&P defends futures-based ETPs

Investing in commodities through ETPs tracking futures helps stimulate supply in the underlying assets, says S&P head of commodity indices Mike McGlone.

Many ETPs providing exposure to commodities track an index that invests in a basket of futures contracts, often across a number of markets.

McGlone says using indices such as the S&P GSCI, one of the most widely followed benchmark for commodities, never directly impacts on supply and demand but does influence prices.

He adds: "If you bid up price, you create supply."

McGlone also defends futures-based investments against the accusation that returns are eroded by the cost of rolling over contracts when the market is in contango.

He points out such effects are cyclical, balanced by periods of backwardation, and that conditions vary widely across the commodities universe.

"Basically you have to ask yourself whether you can store something in your basement. Natural gas is the pariah of commodities investing - it is almost always in contango. Gold, on the other hand, has historically had a very flat roll expense."

In fact, S&P's figures show that it is industrial metals that have benefited the most from backwardation over the ten years up to 2010, and the only sector of commodities where total returns have exceeded those of the spot price.

Recent innovations in the ETP industry have opened up new ways for investors to gain access to industrial metals, with the introduction of a raft of physically-backed ETCs in copper, aluminium and nickel, among others.

However, McGlone argues that these ETPs influence the market in a way futures investing does not. He says: "With a physically-backed ETP it is theoretically impossible not to positively impact on demand for that commodity."

What the development of physically-backed ETCs attests to, however, is the rapid expansion of both assets and sophistication in commodities investing. S&P estimates there was roughly $100bn tied to its GSCI index at the end of 2010, and $175bn assets across commodities indexing. 

Despite the apparent dominance of the GSCI, McGlone says its relative underperformance since 2008 has prompted a migration towards enhanced indices, although S&P has now filled the gaps in its offering with the recent launch of its GSCI Dynamic Role index. He says: "I think we've pretty well saturated the market for now. There's just one other long/short index to come."

Currently, the firm's ambitions are constrained by the scarcity of liquid futures markets, but as developing countries open up, McGlone gives an insight into an area of likely future expansion.

He says S&P already offers a World Commodity index, tracking futures from international exchanges outside the US, as well as WCI Asia and WCI Europe indices, but while interest is voluble investments remain small. As the profile of emerging markets grows however, targeted commodities investing looks set to become increasingly popular.