Contango and Backwardation are very important to understand for any portfolio manager or investment team that is invested in the commodity complex or is contemplating a placement. The implications of the construction methodology are huge as your firm will not likely be buying currently produced commodities but rather the price of a contract of oil and corn in the future.

Contango and Backwardation describe the cuurent state of a futures curve typically found in broad based commodity indexes. Most will not have spot(todays price) represented but rather will hold various futures contracts.

Contango-The futures contract price is more expensive than the current price.
Backwardation-The futures contract price is less expensive than the current price.

This is important as studies have demonstrated that over time buying indexes in contango leads to subpar performance. Since most ETFs and funds that hold long only commodity indexes are subject to varying degrees to this risk,  Zenith recommends a thorough examination of your current or prospective holdings in this area.

Unless the index product has enough flexibility to mostly mitigate the adverse effects of contango, we would not allocate risk capital there.
Tom Koehler, CFA

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