Commodity exchange-traded products (ETPs) are one of the fastest-growing areas of the tracker market. But this growth has been accompanied by increasing complexity in product structure. Paul Amery, editor of IndexUniverse.eu, asked Christos Costandinides, ETF strategist at Deutsche Bank and author of a comprehensive new report (“The Race For Assets in the European Commodity ETP Space), to throw light on the subject.

IU.eu: Why do you think commodity ETPs are the fastest-growing area of the market?

Costandinides: First, because this area of the market is newer than the more traditional equity and fixed income ETF sectors, the number of product launches is very high. Second, we’ve gone from a period in the markets which encompassed the credit crunch and high volatility and where there was strong demand for gold ETPs, but now we’re beginning to see some move away from gold, with people diversifying into other areas of the commodities market. Finally, the broader range of products has made commodity investing much more accessible than it used to be.

IU.eu: In your report you mention industrial metals and broad commodity index trackers as the two categories you expect to grow fastest. Why is that?

Costandinides: Partly as the result of the impact of the economic environment, partly (in the case of diversified commodity funds) since these are the only type of raw materials trackers permitted as funds under the EU’s UCITS regulations, meaning that there is a natural demand for them.

IU.eu: You also expect the Swiss gold ETFs to benefit?

Costandinides: Yes, since the Swiss aren’t in the EU and their regulations permit funds to track single commodities. Also, while the European exchange-traded products market is highly institutional, the Swiss market has a much greater concentration of high-net-worth individuals, who have a natural demand for such funds.

IU.eu: One of the charts in your report shows that the contango in oil in 2009 was the biggest for 20 years. Since oil trackers lagged the spot oil price so severely last year, returning only single figures while spot oil was up 78%, hasn’t this put investors off?

Costandinides: I think that we have to start from the premise that the fundamentals of the relevant commodities market carry through to the relevant exchange-traded product. What you’ve described is not news. One also has to ask what the alternative is. Most investors can’t buy and store a tonne of oil, for example, and are forced to buy futures-based products, where the effect of contango and backwardation will inevitably be felt. The spot price in many commodities is an academic concept and does not represent an investable return.

IU.eu: You’ve highlighted in your report an area of return measurement that can confuse investors. Could you elaborate?

Costandinides: There is still a lot of confusion in the market concerning “total return” and “excess return” in ETPs.

Investors are handing over cash to ETP providers and should expect to receive a total return: the return on the asset or the rolled futures position, plus the funding return.

However, several ETP providers deduct a cost of collateral from this total return, turning their products from total into what are effectively excess return products (since, in the current market, the collateral cost is often close to the funding return).

This is an area that still lacks transparency and, as the market grows, we expect competition to force more openness and lead to some repricing of products.

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