What is roll yield in commodities, and how do contango and backwardation affect commodity fund returns?

Roll yield is one of the most misunderstood concepts in commodity investing, and it's crucial for CFA Level I. Let's demystify it.

Why Commodity Funds Use Futures:

You're right — most commodity investors don't hold physical commodities (imagine storing 10,000 barrels of crude oil!). Instead, they hold futures contracts. As each contract approaches expiration, the fund must 'roll' — sell the expiring contract and buy the next-month contract.

The Three Components of Commodity Returns:

1. Spot return (price return): Change in the commodity's spot price
2. Roll yield: Gain or loss from rolling futures contracts forward
3. Collateral yield: Interest earned on the margin/collateral (typically T-bills)

Total Return = Spot Return + Roll Yield + Collateral Yield

Contango vs. Backwardation:

Contango Example (Negative Roll Yield):

Crude oil spot price: $75. One-month futures: $76. Two-month futures: $77.

You hold the 1-month contract at $76. At expiration, it converges to spot ($75). You sell at ~$75 and buy the 2-month (now 1-month) at ~$77.

You sold at $75 and bought at $77 → lost $2 on the roll per barrel.

Backwardation Example (Positive Roll Yield):

Crude oil spot price: $75. One-month futures: $73. Two-month futures: $71.

You hold the 1-month contract at $73. At expiration, it converges to spot ($75). You sell at ~$75 and buy the new front month at ~$73.

You sold at $75 and bought at $73 → gained $2 on the roll per barrel.

Why This Matters for Investors:

Historically, many commodity markets have been in contango much of the time, which means commodity futures investors can lose money even when spot prices are flat or rising slowly. This is sometimes called the 'roll yield drag.'

What Drives the Curve Shape?

• Contango causes: Storage costs, insurance, financing (it costs money to hold physical commodities)
• Backwardation causes: Supply shortages, convenience yield (producers value having physical inventory on hand), strong near-term demand

Exam tip: CFA Level I tests whether you can identify contango vs. backwardation from a futures curve and determine the sign of roll yield. Remember: contango = negative roll yield (headwind), backwardation = positive roll yield (tailwind). Also know that the total return on a fully collateralized commodity futures position includes all three components.

For more on commodities and alternatives, explore our CFA Level I course on AcadiFi.