ETF Forwards - How Do they Work?

mr_fishbulb

ETF Securities have some 3-month forward versions of their ETCs (F3s)

Looking at the performance of the All Commodities Forward (FAIG), the returns are a lot higher over the non-forwarded version. How can that work? I thought the returns would be the same but 3 months in advance? Or am I missing the point completely? I've had a google but haven't found much.
http://www.etfsecurities.com/en/securities/etfs_performance.asp

Will this deviation also be true in a bear market? Will the prices of the forward ETFs drop a lot quicker than the non-forwards?

Also what do people thin kof this ETF? Good for 2008?

jon3001

mr_fishbulb wrote: »

ETF Securities have some 3-month forward versions of their ETCs (F3s)

Looking at the performance of the All Commodities Forward (FAIG), the returns are a lot higher over the non-forwarded version. How can that work? I thought the returns would be the same but 3 months in advance? Or am I missing the point completely? I've had a google but haven't found much.
http://www.etfsecurities.com/en/securities/etfs_performance.asp

Will this deviation also be true in a bear market? Will the prices of the forward ETFs drop a lot quicker than the non-forwards?

Good questions and I've been wondering as much myself. I'm far from an expert so have been digging into it myself. The F3 indices seems to have substantially better performance with less volatility.

Some info on the FT regarding a rival forward index:
http://www.ft.com/cms/s/0/4eb2e440-a821-11dc-9485-0000779fd2ac.html

The futures curve shape is a key element for the profitability of commodities indices investing.

In addition to the spot return, investors in commodity indices obtain a separate return every month, known as the roll yield, from the shape of the curve. Investors tend to roll their index trade over each month, just before the contract expires.

That return is positive when futures prices are lower than the prevailing front-month price – a backwardation – and negative when futures prices are higher – a contango.

The impact of a contango market is especially acute at the front of the futures curve and usually its impact is lesser in long-term prices.

“The index could help alleviate the effects of the contango,” Mr Kolts said, adding that there was sufficient liquidity in the first five months of the futures curve to relocate some investment out of the first contract.

As a current example:

WTI Crude oil spot prices today were $95.68.
http://newsvote.bbc.co.uk/1/shared/fds/hi/business/market_data/commodities/28698/default.stm

Here are the contract prices:
http://www.nymex.com/lsco_fut_cso.aspx
Feb 2008 96.62
Mar 2008 96.27
April 2008 95.62
May 2008 94.97
June 2008 94.34
July 2008 93.73

So you can see that in the short term you end up 'buying high and selling low' and you're relying on spot prices rising above $96.62 to save you. However, further out on the yield curve you can buy at $93.73 and, if spot prices remained static, sell at $95.68 at a profit. Of course, if spot prices rose or fell in the meantime then that also affect your profit.

I think part of the price difference is that producers want to lock in prices and are so are willing to aceept larger premiums for selling further into the future. Effectively you are selling them insurance against falling prices.

As far a differences in bear market or other market environments - I've no idea. My gut feeling is that F3 products are probably superior overall. I think ETF Securities introduced them because of investor demand - investors who are more savvy than I such as institutional investors.

mr_fishbulb wrote: »

Also what do people thin kof this ETF? Good for 2008?

I currently own AIGC and have been buying on a monthly basis to smooth out volatility. On my next purchase I'm strongly considering moving the holding into FAIG.

As far as commodities in general go - I think they're a great diversifier in one's portfolio. Long term returns and volatility are similar to equities whilst being uncorrelated.

Jim Rogers thinks commodities are undergoing a bull market due to supply/demand issues. Lack of investment in mining, agriculture, etc has hindered supplies whilst demand is growing from China, India, etc. Look out for his 'Hot Commodities' book on Amazon.

sixtytwo

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wombat42_2

I'm still not clear if Forward ETFs are good for everyone and whether they just provide slightly geared versions of standard ETFs so both rises and falls are magnified.

jon3001

Dow Jones publish historical index data going back to 1991.
http://www.djindexes.com/mdsidx/index.cfm?event=showAigDataCharts

The F3 indices have outperformed the standard indices handsomely over the past 17 years.

You need to read up on contango and backwardation if you want to understand the returns from commodity futures.

But basically the returns from buying longer-dated contracts and selling them close to maturity have been better than the same with shorter-dated contracts. I'm sure you can find periods when this wasn't the case but given the data I'm playing the odds and going with F3.

If there are significant price differences long-dated contracts and short-dated contracts + storage costs then the big players will move in and arbitrage it away. E.g. they could buy cheap oil on the open market, store it and sell contracts to delivery it at a higher price in months to come.

Volalitily is lower too. I.e. you seem to get much more price fluctuation as contracts near maturity and therefore there's more potential for a loss.

purch

I'm still not clear if Forward ETFs are good for everyone and whether they just provide slightly geared versions of standard ETFs so both rises and falls are magnified.

Yeah......................whatever !!!!! :T :rotfl::rotfl:

How can that work?

It might be wise to remember that any ETF is just a derivative of it's underlying index (which itself is a derivative as well), so it is important to understand what that index consists of, and how the underlying index is traded. A basic understanding of a Yield Curve, and how Yield Curve trading works will help your understanding as basically the concept holds true for any Futures market

http://www.cbot.com/cbot/pub/cont_detail/0,3206,1212+12541,00.html

....however the Financial Futures markets don't roll over from contract to contract, whereas some Commodity Futures markets do. It's this rollover that creates the 'roll yield', which can add significantly to the return/loss on trading. Rolling into a more expensive contract (Contango) is a loss, rolling into a cheaper contract (Backwardation) make a gain.

Lots of people are jumping into ETC's as an easy way of getting exposure to Commodities without even a basic idea of how the underlying index works. The Commodity Futures markets are very technically driven, and are affected by many influences including seasonality. It's not just a case of 'Duh!! I think it's going up, so I'll buy it !!!!'

Without a proper understanding it could be a dangerous and costly decision.

P.S. The ability to 'Short' the Index via an ETF will add greatly to the trading mix going forward

wombat42_2

jon3001 wrote: »

Dow Jones publish historical index data going back to 1991.
http://www.djindexes.com/mdsidx/index.cfm?event=showAigDataCharts

The F3 indices have outperformed the standard indices handsomely over the past 17 years.

You need to read up on contango and backwardation if you want to understand the returns from commodity futures.

But basically the returns from buying longer-dated contracts and selling them close to maturity have been better than the same with shorter-dated contracts. I'm sure you can find periods when this wasn't the case but given the data I'm playing the odds and going with F3.

If there are significant price differences long-dated contracts and short-dated contracts + storage costs then the big players will move in and arbitrage it away. E.g. they could buy cheap oil on the open market, store it and sell contracts to delivery it at a higher price in months to come.

Volalitily is lower too. I.e. you seem to get much more price fluctuation as contracts near maturity and therefore there's more potential for a loss.

It is very weird that H&L dont allow ETF forward agriculture but they do allow ETF forward grains.

jon3001

wombat42 wrote: »

It is very weird that H&L dont allow ETF forward agriculture but they do allow ETF forward grains.

Like I've said before: some of these securities are fairly new and they probably just need a nudge to add it to their system.

purch

H&L dont allow ETF forward agriculture

It will depend on the liquidity of the ETF and the ability of HL to get a 'market maker' to provide a price.

The less liquid securities cannot be traded online, but HL will be able to get a price if you phone them.

Unfortunatly you won't be able to track the price 'live' online

jon3001

BTW I was only looking at data for broad indices such as those tracked by AIGC and FAIG. If you're going down to sector level (or even individual commodities) then check the data yourself to see which parts have of the yield curve have performed best. If there's no clear winner (taking into account volatility) then you could consider diversifying across both parts.

http://www.djindexes.com/mdsidx/index.cfm?event=showAigDataCharts

wombat42_2

This gives performance info.
http://www.etfsecurities.com/en/securities/etfs_performance.asp

I am only basically drilling down as far as Agriculture in general but might be tempted by a grain ETF as they are hottest right now