How Contango and Backwardation Affects the Performance of Commodity Hedge Funds? Evaluation Based on Commodity Trading Advisors’, CTA

In this article, we examine how contango and backwardation affects the performance of commodity hedge funds. Evaluation based on commodity trading advisors’, CTA. CTA, commodity trading advisers, or managed futures managers’ trade in the commodity market. The hedge funds invest in commodity futures, currencies, bonds and shares. The portfolio is leveraged and the risk is quite high. Forward and futures contracts have similarities in terms that they involve two parties to exchange a commodity, a currency or a bond at a specified price in the future. The costs of carry that characterize these contracts are insurance, storage and interest costs. Backwardation is a case where the futures price is below the spot price. It takes place when there is advantage to hold the underlying asset that offset the opportunity cost of the risk-free rate and additional net holding costs. In contrast, contango is a case where the futures price is above the spot price. In a speculation situation, the futures prices do not equal spot prices and speculators are taking advantage from the mispricing. Speculators are short or long according to if the futures market is in backwardation or in a contango situation. In case, that the investor is not getting dividends, semi-annual coupons or monthly yields and the futures price are less than the spot prices, then, we are discussing about a backwardation effect.