WisdomTree Commodity ETF FAQs

There are three ways to invest in commodities:

• Buying the physical assets – for example gold coins or bars.
• Buying shares in commodity-related companies such as miners.
• Indirectly through a fund, investment trust, exchange traded fund (ETF) or exchange-traded commodity (ETC) that invests in commodities or commodity-related investments. 

Commodities tend to have little investment performance correlation with shares and bonds. This means when prices of shares bond prices fall or rise, the price of commodities won’t necessarily fall or rise at the same time. It doesn’t always hold true so investors can’t rely on this. However, commodities can still be very useful for diversification purposes to hold alongside other assets – such as shares and bonds. 

Exchange-traded funds (ETFs) are divided up into types called ‘physical’ and ‘synthetic’. Synthetic ETFs, in contrast to a physical ETF, do not physically own the assets in the index they are following. Instead, the index is replicated through swap transactions. A swap contract, which is purchased from a counterparty, usually a bank, is an agreement to provide the total return of the index the ETF is following. For doing this, the ETF provider pays the counterparty a fee for the swap contract. One of the big risks of synthetic ETFs is so-called counterparty risk. This means the risk that the counterparty (the bank in the swap agreement) failing to deliver their obligations, for example if they become insolvent. 

This distinction is slightly different with commodity ETFs. Some commodity ETFs may be physically replicated. So, for example, a physically replicated gold ETF will mean the ETF owns actual gold bars sitting in a vault. 

However, it is not possible to do this with many commodities because they are unsuitable for storage or more difficult to store. This is why some ETFs are synthetic and buy futures contracts, which is an agreement to buy the commodity at a set price at a set date. 

Smart beta is an investment strategy used by certain types of exchange traded funds (ETFs) that take more factors into account when choosing assets for the benchmark index than traditional ETFs.

Rather than attempting to track the price of a traditional index like a passive strategy, smart beta ETFs include extra rules that take factors like risk management and diversification into consideration. The aim is to outperform like an active strategy but with lower costs. In the case of this ETF, it invests in different dated commodity future contracts than the traditional index, with the ultimate goal of providing a higher return than the index.

A futures contract is a legal agreement to buy or sell a particular asset at a predetermined price at a specified time in the future. A swap contract, which is purchased from a counterparty, usually a bank, is an agreement to provide the total return of the index the ETF is following. Both contracts allow investors to gain access to the returns of an asset class like commodities without the need to store the assets physically. 

The futures curve is a graph that illustrates the price at which futures contracts, with different maturities, may be bought or sold today. When the futures curve is upward sloping, i.e., prices of contracts with longer maturities are higher than those with shorter maturities, the curve is said to be in “Contango”. In the opposite case when the futures curve is downward sloping, i.e., prices of contracts with shorter maturities are higher than those with longer maturities, the curve is said to be in “Backwardation”.

The shape of the futures curve and whether it is in Contango or Backwardation has implications on the periodic rolling of contracts as rolling generates a “roll yield”, which can be positive or negative. When the curve is in Contango the roll yield will be negative as the investor will be “rolling up” the curve - paying more to buy the new contract than they received from selling the old contract. This results in a loss for the investor i.e., negative roll yield. 

Alternatively, when the curve is in Backwardation the roll yield will be positive as the investor will be “rolling down” the curve - paying less to buy the new contract than they received from selling the old contract. This results in a gain for the investor i.e. a positive roll yield.

If a commodity fund invests in front month contracts, it provides exposure to the nearest contract on the futures curve - the one with the shortest maturity. This approach is designed to get the maximum exposure to the spot price movements of commodities. Each time the front month contracts expire a front month strategy will roll onto the next contract which then becomes the new front month contract. The Bloomberg Commodity Index is an example of a strategy that invests in front month contracts.

By holding futures, commodity investors are exposed to three return components:

Total Return =

Spot Return + 
(Return associated with spot price of commodity)

Roll Return +
(Return from maintaining futures exposure by rolling positions from one contract into another)

Collateral Yield
(Return from collateral used to guarantee futures position)

Each component plays an integral part in defining commodity investors’ overall returns, however, the roll return is an often forgotten aspect that can define a strategy’s performance. This is because futures contracts typically have standardised dates for expiry, and it is necessary to move from an existing contract to the next available contract in order for an exposure to be maintained - a process otherwise known as rolling. 

By focusing on managing roll yield, dynamic roll strategy typically positions further out along the futures curve when in contango. This makes such strategies inherently less sensitive to spot price movements, suppressing volatility relative to front-month roll strategies. Investors generally benefit from this roll methodology because it is dynamic and responds to changing market conditions. An “Optimised Roll” means that the strategy seeks to maximise the positive roll yield impact (normally when curves are in backwardation) and minimise the negative roll yield impact (when curves are in contango).