Futures-based commodity indexes have four sources of returns:

1. Spot
2. Rolling
3. Collateral
4. Rebalancing

Spot returns are simply the returns resulting from the underlying commodity’s price movements.

Rolling returns are achieved by closing one futures contract and taking a position in another futures contract with a later expiration date. This is done to avoid taking delivery of a commodity and to maintain a long position. Returns from the rolling process are possible especially when, close to a contract’s expiration date, nearby contracts are trading at a higher price or premium to those that are due to expire at a later date, a situation known as “backwardation.” Rolling allows capturing
returns from possible commodity backwardations as the contract rolls over higher-priced futures contracts into more distant lower-priced contracts.

Roll returns tend to be negative when a futures price is above the expected future spot price, a situation known as “contango,” and positive when the futures price is below the expected future spot price, i.e., when the market is in backwardation. The shorter roll-period results in relatively lower roll costs whereas the longer roll process may have a better chance to capture backwardation.
 

Collateral returns result from placing margin or full face value of futures contracts with CME Group which earns interest, called “T-bill yield.” A fully collateralized futures position would be comparable to a long position in stocks or bonds.

Rebalancing returns result from reallocating positions out of the commodities in an index that have appreciated into those that have underperformed. To the extent that commodity markets exhibit mean-reverting characteristics over time, this approach may result in higher returns. If rebalancing takes place on a daily basis, the strategy will involve selling into an uptrend and buying into a downtrend. It never allows profits or losses to run, contributing to their lower volatility.