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Roll yield

USD vs UNG Roll Yield Comparison

Pomegra Learn

USD vs UNG Roll Yield Comparison

Examining roll yield impact across multiple commodity ETFs reveals striking differences in how market structure and fund design determine investor outcomes. The United States Commodity Index Fund (USCI) and the broader category of commodity index ETFs, when compared directly with commodity-specific products like the United States Natural Gas Fund (UNG), demonstrate how commodity selection, storage economics, and fund structure create vastly different return profiles. A systematic comparison of roll yield impact across commodity ETF categories shows that not all commodity exposure is equal, and that the drag from rolling varies by four, five, or even six orders of magnitude depending on the underlying commodity and fund structure. Understanding these differences is essential for investors seeking diversified commodity exposure without incurring excessive roll yield losses.

The Commodity Index Fund Approach​

Commodity index funds like the United States Commodity Index Fund and similar products employ diversified baskets of commodity futures rather than exposure to a single commodity. These funds typically allocate capital across crude oil, natural gas, heating oil, gasoline, wheat, corn, soybeans, copper, gold, and other commodities, reweighting periodically to maintain target allocations.

The diversified approach creates an important benefit: while some commodities in the basket face severe contango (natural gas, crude oil), others have minimal or even negative contango (gold, certain precious metals). The aggregate roll yield impact is therefore the weighted average of individual commodity impacts, which is generally less severe than holding any single commodity alone.

Historical performance data for commodity index funds shows this effect. A broad commodity index held from 2007 through 2023 might deliver returns that track the Bloomberg Commodity Index within 100 to 200 basis points annually. This is substantially better tracking than UNG alone, despite both funds facing contango rolling costs, simply because the commodity index spreads its roll yield drag across multiple underlying commodities with different market structures.

The Roll Yield Drag Quantification​

To compare roll yield impact systematically, consider the annual impact for each major commodity in a typical commodity index:

Crude Oil (WTI): 2 to 3 percent average contango spread, compounding to approximately 24 to 36 percent annual roll yield drag in contango-typical years.

Natural Gas: 6 to 10 percent average contango spread, compounding to approximately 55 to 85 percent annual roll yield drag.

Heating Oil and Gasoline: 1 to 2 percent average contango spread, approximately 12 to 24 percent annual drag.

Gold: 0.05 to 0.5 percent average contango spread, approximately 0.6 to 6 basis points annual drag.

Copper: 0.5 to 1.5 percent average contango spread, approximately 6 to 18 percent annual drag.

Agricultural Commodities (Wheat, Corn, Soybeans): 0.5 to 2 percent average contango spread, approximately 6 to 24 percent annual drag.

In a diversified commodity index with typical allocations (roughly 25 percent energy, 25 percent precious metals, 25 percent industrial metals, 25 percent agriculture), the weighted average roll yield drag would be approximately 15 to 25 percent per year, far lower than holding natural gas alone but still material.

This calculation assumes each commodity rolls monthly; longer roll intervals reduce the drag proportionally.

UNG as the Extreme Case​

The United States Natural Gas Fund, LP represents the extreme end of the roll yield spectrum. With annual roll yield drag sometimes exceeding 50 percent, UNG essentially guarantees significant underperformance relative to spot natural gas prices except in years when natural gas prices rise more than 50 percent, which occurs rarely.

From 2007 through 2023, UNG delivered negative 99 percent cumulative returns while the spot price of natural gas ranged from 2.50 to 12.00 dollars per million BTU over the period. The fund's performance has been mathematically determined by the contango structure of natural gas markets, not by natural gas price movements.

Most commodity index funds did not hold substantial natural gas allocations precisely because natural gas's roll yield drag is so severe that it dominates returns. By excluding or minimally weighting natural gas, commodity indices achieve significantly better tracking performance than they would if weighted to commodity production or market capitalization.

Cross-Commodity Index Comparison​

The Diversified Commodity Index (DCI), the iShares Commodities ETF (DBC), and the Invesco Commodity Index ETF Trust (DBC) all employ similar diversified approaches but with slightly different reweighting methodologies and commodity selections. Performance comparison from 2008 through 2023 shows:

  • Broad commodity indices: approximately 100 to 200 basis points annual underperformance relative to their stated index methodologies
  • Natural gas-heavy indices: approximately 200 to 400 basis points annual underperformance
  • Precious metals-focused indices: approximately 20 to 50 basis points annual underperformance
  • Agricultural commodities indices: approximately 50 to 150 basis points annual underperformance

The pattern is clear: as natural gas weight increases, underperformance accelerates. As precious metals weight increases, underperformance declines. The overall impact is dominated by commodity selection and market structure, not by fund management quality or explicit fees.

Why Commodity Index Construction Matters​

A seemingly small decision—whether to weight commodities by production, by market cap, by volatility, or by price impact—creates substantial differences in expected roll yield drag. An index weighted by production would allocate heavily to crude oil and natural gas because these are the highest-production commodities globally. Such an index would face roll yield drag of 20 to 30 percent per year from energy commodities alone.

An index weighted by storage cost (attempting to avoid high-carry commodities) would allocate heavily to precious metals and avoid natural gas. This index would face roll yield drag of less than 5 percent per year but would sacrifice energy exposure.

Most commodity index providers have implicitly learned this lesson, creating indices that weight commodities to balance diversification objectives against roll yield considerations. But few index sponsors explicitly highlight this tradeoff or acknowledge that their weighting methodology is partially an attempt to minimize roll yield rather than achieve theoretically optimal diversification.

Volatility and Roll Yield in Contango​

A secondary effect that varies across commodities is the interaction between volatility and contango. Natural gas and crude oil, which face significant contango, are also highly volatile. This combination creates a particularly adverse situation for rolling: the fund must roll at the highest contango spreads precisely when volatility is highest and prices are moving most dramatically.

Precious metals, which have minimal contango, are also generally less volatile. This creates a favorable combination: minimal roll costs occur during periods of stability, and on the rare occasions when volatility spikes, the fund's roll mechanics remain benign.

Agricultural commodities show intermediate patterns: moderate contango and moderate volatility. The interaction is neither particularly favorable nor catastrophic.

Impact of Roll Frequency​

Most commodity ETFs roll monthly, but some academic research and institutional practices suggest that less frequent rolling might reduce the mathematical impact of contango. A fund that rolled quarterly rather than monthly would lock in contango spreads only four times per year rather than twelve, potentially reducing roll yield drag by 67 percent. However, quarterly rolling would increase tracking error and basis risk due to infrequent rebalancing.

In practice, most commodity index funds and commodity ETFs stick with monthly rolling as a compromise between minimizing basis risk and achieving reasonable tracking performance. Some specialized commodity indices and institutional strategies employ longer roll windows, accepting some tracking error in exchange for reduced roll yield costs.

Lessons for Investors​

A direct comparison of roll yield across commodity ETFs reveals that investors cannot treat commodity exposure as homogeneous. The choice of commodity, fund structure, and rolling methodology creates outcome differences that dwarf explicit fee differences. A fund with a 0.5 percent expense ratio in a commodity with minimal contango will significantly outperform a fund with a 0.7 percent expense ratio in a commodity with severe contango.

For investors seeking diversified commodity exposure, broad commodity indices offer better diversification benefits and lower average roll yield drag than single-commodity products. For investors specifically seeking natural gas exposure, understanding that the product is mathematically designed for short-term trading rather than long-term investing is essential.

A practical approach to commodity investing that accounts for roll yield differences would be to allocate heavily to low-roll-yield commodities (precious metals, some industrial metals) and minimize allocations to high-roll-yield commodities (natural gas, some energy products), accepting that this creates a portfolio that diverges from theoretically optimal diversification weights.

Key Takeaways​

Roll yield impact varies dramatically across commodities and commodity ETFs, ranging from less than 10 basis points annually for gold-backed funds to more than 50 percent annually for natural gas products. Commodity index funds that employ diversified baskets face average roll yield drag of 15 to 25 percent per year, less than single-commodity products but material nonetheless. The choice of commodity, weighting methodology, and rolling frequency together determine investor outcomes more decisively than explicit fund fees. Investors should evaluate commodity funds not merely on stated expense ratios but on the underlying commodity selection and market structure implications for roll yield. A broad, diversified commodity index designed to minimize roll yield exposure through careful commodity selection will substantially outperform a poorly weighted commodity index that happens to hold large allocations to high-contango commodities like natural gas.

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