SM Bache Commodity Index SM Q3 2009 Review
The Bache Commodity Index SM Built for Commodity Investors The Bache Commodity Index SM (BCI SM ) is a transparent, fully investable commodity index. Its unique index construction results in lower turnover and lower risk than other commodity indices while maintaining the potential for highly attractive returns. Predictable, Consistent Exposure The BCI is designed to prevent single commodity or sector dominance while preserving broad-based commodity diversification. This is accomplished by employing upper and lower bounds on investment in each sector and each commodity, while rebalancing daily to maintain the desired exposure to each commodity market. BCI Benefits from Multiple Sources of Return The BCI is designed to provide investors with additional sources of return not offered by existing broadbased commodity indices. Historical tests show that the BCI s unique asset allocation and roll methods contributed significantly to the overall return of the index. Momentum Means Greater Return, Less Risk Commodity markets have historically exhibited short-term momentum. Our view is that using momentum to size positions is more profitable than holding fixed positions. By tactically reducing the risk of various commodities, the BCI holds an average of 30% less exposure than a fully invested strategy. As a result, the volatility of the BCI is roughly 30% less than some of the other long-only commodity indices. Diversification, Inflation Hedge for Portfolios Like other commodity indices on the market, the BCI offers potential for attractive returns, inflation protection and diversification benefits. Unlike other indices, the BCI offers these benefits while reducing the potential downside risk of commodity investing. BCI Strategy for Outperformance The development of the BCI represents a significant advancement in commodity indexing methodology. The index was designed using the view that the way commodities are held in a commodity index is as important as the choice of commodities and weights. Actively managed commodity programs do not hold a constant level of exposure either to individual commodities or to the commodity markets as active managers vary exposure to particular commodities and sectors over time. The BCI is the first commodity index to incorporate this feature of dynamic asset allocation into an indexing framework. This is achieved while still preserving the essential properties that make commodity investment attractive to many institutional investors. There are several investment strategies in commodity markets, including the buy-and-roll strategy, spread trading, and directional trading. However, major benchmarks currently only emphasize one strategy, the buy-and-roll strategy embedded in indices such as the S&P Goldman Sachs Commodity Index (SPGSCI) and the Dow Jones-UBS Commodity Index (DJUBS). Other common strategies such as spread trading and directional trading are important potential sources of return for investors but are not captured by these existing benchmarks. The BCI includes sources of return that offer the investor a more predictable, positive expected return. The three factors incorporated in the index are Beta, Daily Roll, and Structured Asset Allocation. While these return factors are not new, this is the first time multiple return factors have been combined into an investable commodity index.
Table of Contents Performance Summary Comparison with Commodity Benchmarks Sector Analysis Analysis of Return Sources Q3 2009 Economic Environment for Commodities Summary Appendices Weights of BCI Commodities and Sub-Indices Analysis of Dynamic Weighting Changes Q3 2009 Monthly BCI Returns January 1991 to September 2009 This report was prepared by Alternative Investment Analytics LLC (AIA) under the direction of PFDS Holdings, LLC pursuant to an agreement between AIA and PFDS Holdings, LLC. Prudential Bache Asset Management (PBAM) is a business unit within Bache Commodities Group. PBAM is registered with the SEC as an investment adviser and as a commodity trading adviser with the CFTC. PBAM's affiliated brokers, Prudential Bache Commodities, LLC (PBCL) and Bache Commodities Limited (BCL) provide advice, sales and trading on a global basis for a wide variety of commodity, financial, and foreign exchange futures and forward contracts. PBAM's parent company, PFDS Holdings, LLC, is the developer and manager of Bache Commodity Index SM (BCI SM ). For more information, please contact Mitzi Noma (Mitzi.Noma@bache.com) or Laryssa Temnycky (Laryssa.Temnycky@bache.com).
675 Exhibit 1: BCI SM Daily Total Return Index Jan 1-Sep 30, 2009* 650 625 600 575 550 525 1/01 2/02 3/02 4/01 5/01 6/01 7/01 8/03 9/01 9/30 * Zinc was replaced with Nickel on March 2, 2009. Calculation for YTD Metals Sector Return includes Zinc s return for the first two months of 2009. Sector Returns are determined by the commodity performance and the weight of the each commodity in the BCI SM. Source: Bache Commodities Group 1
2009 Q3 Report Performance Summary The Bache Commodity Index (BCI) fell 1.2% in the third quarter of 2009. The index moved in a narrow range for most of the quarter. Exhibit 1 on page 1 summarizes the daily growth of the total return index i year-to-date (Q3 in pink.) The Agriculture and Energy sectors both moved lower in the quarter, while the Metals sector had a banner performance, rising 13.1%. Exhibit 2 shows the composite index, sector, and individual commodity performance for the quarter. Exhibit 3: BCI Q3 2009 Performance Compared to Historical Pro Forma BCI SM Total Returns* Q3 2009 1991-2008 Average Monthly Returns -0.4% 0.9% Largest Monthly Return 0.6% 12.7% Largest Monthly Decline -1.4% -10.9% Standard Deviation 17.3% 12.8% * Returns prior to June 2007 are pro forma. Q3 2009 Standard Deviation uses daily total returns while 1991-2008 uses monthly total returns. Source: Bache Commodities Group Comparison with Commodity Benchmarks Exhibit 4 shows relative performance of the S&P GSCI (SPGSCI), the Dow Jones-UBS Commodity Index (DJUBS), and the BCI. The BCI return in the third quarter was higher than the SPGSCI but lower than the DJUBS. The dominance of the Metals sector in the third quarter, as well as throughout the year, boosted the performance of the DJUBS above the other two commodity benchmarks. The DJUBS allocates more than 30% of the index weight to Metals, as compared to 20% by the BCI SM and less than 20% by the SPGSCI. The weakness in the Energy sector weighed on the performance of the SPGSCI in the third quarter. The BCI continued to have the lowest volatility among the three benchmark indices for the quarter, as well as year-todate for 2009. The volatility of the BCI is almost half that of the SPGSCI on both a quarterly and year-to-date basis. Source for BCI SM Data: Bache Commodities Group. Source for SPGSCI and DJUBS Data: Bloomberg, LP. i and ii: Please see Notes on page 8 2
270 Exhibit 5: 5: BCI BCI Agriculture SM Total Total Return Index Jan Jan 1-Sep 30, 2009* 260 250 240 230 220 1/01 2/02 3/02 4/01 5/01 6/01 7/01 8/03 9/01 9/30 1100 Exhibit Exhibit 6: BCI 6: BCI Energy SM Energy Total Total Return Return Index Index Jan 1-Sep Jan 1-Sep 30, 30, 2009 2009* 1000 900 800 1/01 2/02 3/02 4/01 5/01 6/01 7/01 8/03 9/01 9/30 640 Exhibit Exhibit 7: BCI 7: BCI Metals SM Metals Total Total Return Return Index Index Jan 1-Sep Jan 1-Sep 30, 30, 2009* 2009* 600 560 520 480 440 1/01 2/02 3/02 4/01 5/01 6/01 7/01 8/03 9/01 9/30 * Zinc was replaced with Nickel on March 2, 2009. Calculation for YTD Metals Sector Return includes Zinc s return for the first two months of 2009. Sector Returns are determined by the commodity performance and the weight of the each commodity in the BCI.. Source: Bache Commodities Group 3
Commodity News Highlights Sugar Reaches 28-Year High in September 9/30/09 Sugar futures rose to the highest in more than 28 years in September, as demand outpaced production in major sugar producing countries. Sugar futures for March delivery rose to 25.43 cents a pound on ICE Futures U.S. in New York. Gold Futures Rise to Record Settlement Price 9/16/09 Gold rose to a record settlement price in September as the dollar was pummeled in global markets. Gold futures for December delivery advanced to $1020.20 an ounce on the Comex division of the New York Mercantile Exchange. Crude Oil Tops $70 per Barrel 9/30/09 Crude oil futures topped $70 per barrel in the third quarter. Oil rose the most in almost six months as gasoline inventories fell. Crude oil increased 1% in the third quarter, a third consecutive quarterly gain. Source: Bloomberg News Analysis of Return Sources Q3 2009 Sector Analysis Contribution of Individual Commodity Markets and Sectors Agriculture: The BCI Agriculture sector composite showed performance of -1.4% in the third quarter. The majority of commodities in the BCI Agriculture sector suffered losses in the third quarter, including Corn, Soybeans, and Wheat. Sugar, the performance outlier in the sector, rose 33.3% for the quarter. Exhibit 5 shows agriculture sector performance. Energy: The BCI Energy sector composite showed performance of -6.7% in the third quarter. All Energy constituents experienced negative, single-digit returns all months of the quarter, except for Natural Gas. Natural Gas posted a 9.8% increase in September although it remains the worst-performing commodity in the index, down 32.5% so far in 2009. Exhibit 6 shows energy sector performance. Metals: The BCI Metals sector composite had a positive performance of 13.1% in the third quarter. All components boasted double-digit returns for the quarter, with the exception of Gold which had a positive quarterly performance of 5.9%. Copper was the top performer of the group with a 21.5% positive performance in the third quarter. Exhibit 7 shows metals sector performance. The Metals sector dominated overall index gains in the third quarter, as all components made positive contributions to the BCI. In the Agriculture sector, both Sugar and Cotton made positive contributions to overall index gains, although all other agricultural commodities detracted from performance. The Energy sector led losses, with all components making negative contributions on the heels of a much greater positive contribution in the third quarter. Exhibit 8 shows the contribution of each index component to the overall BCI performance in the third quarter. Exhibit 9 shows the contribution of each commodity sector to the overall BCI performance in the third quarter. Contribution of BCI Return Factors Exhibit 10 shows the contribution of each BCI style factor to the total return. Given the choppy nature of commodity markets in the third quarter, the Structured Asset Allocation Factor did not contribute to index performance. The Beta Factor iii was also negative, as some commodity prices moved lower. The Daily Roll Factor v contributed 46 bps to the BCI third quarter return. This factor tends to be positive when commodity markets are in contango. The contribution of the Structured Asset Allocation Factor iv was -128 bps, and the contribution of the Beta Factor was -44 bps for the third quarter. For the first three quarters of 2009, the combined contribution of the Structured Asset Allocation Factor was 24 bps. The contribution in the first quarter was 44 bps and in the second quarter was 60 bps. As shown in Exhibit 1 and in Exhibits 5-7, the first three quarters of 2009 were characterized by choppy trading. The only sector showing a consistent trend was Metals, the smallest of the three BCI sectors. iii, iv, v and vii : Please see Notes on page 8 4
Composite Agriculture Energy Metals Composite Agriculture Energy Metals Composite Agriculture Energy Metals Exhibit 8: BCI SM Market Factor Decomposition* Q3 2009 Exhibit 9: BCI SM Market Factor Decomposition* Q3 2009 Exhibit 10: BCI SM Style Factor Decomposition* Q3 2009-1.5-1.0-0.5 0.0 0.5 1.0 Copper 1.02% Sugar 0.79% -4-3 -2-1 0 1 2 3 Beta Factor (70%) iii -0.44 Gold 0.42% Nickel 0.41% Silver 0.36% Aluminum 0.30% M etals 2.52% Daily Roll Factor v (70%) 0.46 Cotton 0.16% Coffee -0.02% Gasoline -0.07% Live Cattle -0.08% Heating Oil -0.18% Agriculture -0.41% Structured Asset Allocation iv Factor -1.28 Soybeans -0.19% Lean Hogs -0.20% Brent Crude -0.34% vi Collateral 0.04 Corn -0.39% -1.22 Wheat -0.49% Natural Gas -0.68% Energy -3.33% BCI Total Return Gasoil -0.72% WTI Crude Oil -1.33% Est. Return (%) -2-1 -1 0 1 *BCI return attributable to each commodity. *BCI return attributable to each sector. *Factor contribution to BCI total return. 16% Exhibit 11: Q3 2009 Returns of BCI SM and Fully Invested Index vii Exhibit 12: Q3 2009 Volatility of BCI SM and Fully Invested Indexvii Exhibit 13: Q3 2009 Sharpe Ratio of BCI SM and Fully Invested Index vii 40% 1.5 BCI Allocation BCI Allocation BCI Allocation Fully Invested Fully Invested Fully Invested 8% 30% 1.0 20% 0.5 0% 10% 0.0-8% 0% -0.5 iii, iv, v, vi and vii : Please see Notes on page 8 Source: Bache Commodities Group 5
Comparison of BCI Returns with Those of a Static Commodity Index Exhibit 11 compares the return of the BCI and BCI sectors to the fully invested index vii. The fully invested index excludes the Structured Asset Allocation iv and the Daily Roll factors v. The BCI performance compared to the static index was mixed in the third quarter. In particular, the quarterly performance of the BCI and fully invested index differed by only 49 bps on a composite basis. The similarity in performance between the two indices was a result of the markets generally moving sideways in the third quarter. The BCI on a composite basis, as well as the BCI Energy and Metals sectors, underperformed the fully invested index and its Energy and Metals sectors. The BCI Agriculture sector outperformed the Agriculture sector of the fully invested index for the third quarter. Volatility was lower in the BCI compared to the fully invested index (Exhibit 12). Economic Environment for Commodities The global economy appears to have begun an expansion as stabilization spread around the globe. Emerging market and developed Asian economies exhibited a relatively strong performance. However, according to the International Monetary Fund (IMF), the pace of overall recovery is slow and economic activity is still far below pre-crisis levels. The IMF is calling for a global economic contraction of about 1.0% for 2009, compared to a forecast of an expansion of about 3.0% in 2010. These projections represent a modest upward revision from July 2009 forecasts as the perspective on global economic growth potential improves. China and other emerging markets continue to exhibit positive growth and the IMF s projections state that this trend will continue. Collectively, emerging economies are expected to lead the near-term growth, with growth expectations of 1.75% in 2009 compared to an expected 3.5% contraction among advanced economies in 2009, the IMF said. Similarly, economists surveyed by Bloomberg News are estimating that the U.S. economy returned to growth in the third quarter. The U.S. Federal Reserve opted to leave benchmark interest rates unchanged in the third quarter although the U.S. Federal Open Market Committee said in September that U.S. economic activity appears to have picked up. The target range for the U.S. federal funds rate was 0 to 0.25% in the third quarter. The dollar experienced a second straight quarterly loss against the euro, with a 4.3% drop for the third quarter. The European Central Bank (ECB) maintained the level of its key interest rate at the recent low of 1.0% through the entire third quarter. The IMF said that a prolonged period of job losses is expected to weigh on European economic activity well into 2010. In Japan, the Bank of Japan s key interest rate remains around 0.1% with no change in the third quarter. Global financial markets continued their steady rise through the third quarter. The S&P 500 Total Return Index rose 15.61% for the quarter, and the MSCI World Index climbed 17.45%. Global bonds gained as well, with the Barclay s Global Aggregate Index up 6.23% in the third quarter. Summary Commodity assets under management rose by $15 billion to $224 billion in the third quarter, with about $12 billion of that total being new money, according to Bloomberg News. Commodity prices appear to be benefiting from the economic recovery in the emerging and developed economies, including India and China. However, at this point, most of the commodity price support appears to be in the industrial metals sector. Looking forward, the rate of global economic growth is expected to increase through 2010, which could lead to additional price support throughout all three commodity sectors. iv, v and vii : Please see Notes on page 8 6
A2: Analysis of Dynamic Weighting Changes Q3 2009 End Jun 2009 End Sep 2009 Q3 2009 Change Min Q3 Weight Average Q3 Weight Max Q3 Weight Corn 5.1 3.7 (1.5) 2.9 3.5 5.2 Soybeans 4.4 2.6 (1.8) 2.4 3.3 4.4 Wheat 3.6 2.0 (1.6) 1.9 2.2 3.6 Coffee 1.7 2.0 0.3 1.1 1.6 2.0 Cotton 1.9 2.1 0.2 1.8 2.0 2.2 Sugar 2.4 2.4 (0.0) 2.4 2.5 2.7 Lean Hogs 1.0 1.9 0.9 1.0 1.4 2.1 Live Cattle 1.4 1.0 (0.4) 1.0 1.7 2.4 WTI Crude Oil 20.0 12.5 (7.5) 7.8 14.7 20.1 Brent Crude 5.0 3.1 (1.9) 2.0 3.8 5.1 Gasoil 9.0 6.1 (3.0) 3.9 7.3 10.1 Gasoline 2.1 1.6 (0.6) 1.4 1.9 2.5 Heating Oil 2.5 1.6 (0.9) 1.0 1.8 2.5 Natural Gas 6.9 8.3 1.5 3.7 4.8 8.1 Copper 5.0 4.5 (0.4) 4.0 4.8 5.2 Aluminum 2.5 1.9 (0.7) 1.9 2.3 2.6 Nickel 2.5 1.6 (0.9) 1.6 2.3 2.7 Gold 5.9 6.6 0.7 4.8 5.6 6.8 Silver 1.9 2.4 0.6 1.4 1.9 2.5 Total Commodity 84.6 67.7 (17.0) 54.4 69.2 84.6 Cash 15.4 32.3 17.0 15.4 30.8 45.6 Source: Bache Commodities Group 7
Source: Bache Commodities Group Notes i. BCI returns quoted in this report are for the Total Return Index, which includes the return of the 91-day Treasury Bill yield in addition to the return attributable to changes in the underlying futures contracts. ii. Standard deviation is calculated as annualized standard deviation of daily total returns. iii. Beta Factor is 70% of the return of the Fully Invested Index (Excess Return). iv. Structured Asset Allocation Factor is the return provided by the dynamic risk reduction methodology. v. Daily Roll Factor is the incremental return attributable to the use of the daily roll methodology versus rolling at the end of the roll period. vi. Collateral is based on the 91-day Treasury Bill yield. vii. Fully Invested Index is calculated using the same weights and roll schedule as the BCI but assumes that rolls take place at the end of the BCI roll period (rather than the daily roll methodology actually employed by the BCI) and is also calculated without the dynamic risk reduction feature of the BCI. As such, the comparison index is always fully invested. 8
Disclosure The returns presented in this document prior to February 1, 2007, were determined based on the pro forma calculations of the historical performance of the BCI SM as well as the fully invested index. Because the BCI was not actually being calculated and published during these prior periods, and no actual trading was conducted in accordance with the BCI, these returns could be considered to be hypothetical performance results. Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any trading program or strategy will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved. One of the limitations of hypothetical performance results is that they are not necessarily prepared with the benefit of hindsight and, if the BCI were actually being calculated and published during these periods, it might have been based on different criteria and a different methodology. Moreover, the market conditions that existed during prior periods will most likely not be repeated and this difference could adversely affect performance. There are numerous factors related to the markets in general or the implementation of any investment strategy, which cannot be fully accounted for in the preparation of hypothetical results, and all of which can adversely affect actual trading results, including but not limited to market liquidity, general levels of interest rates and the effect on the relevant markets of political, economic or other external events. In addition, hypothetical performance results do not involve financial risk, and no hypothetical performance results can completely account for the impact of financial risk in actual performance. The hypothetical performance results shown were derived from a model based on an asset allocation strategy and daily roll strategy. The hypothetical performance reflects the historical contract daily return plus daily interest on the funds hypothetically committed to the investment. The hypothetical performance returns are estimates using current and historical futures price data as described. Historical results should not and cannot be viewed as an indicator of future results. For a more complete description of the BCI, reference is made to The Guide to the Bache Commodity Index SM. The hypothetical performance results do not reflect any management fees, transaction costs or expenses which would reduce your actual return. Indices are unmanaged and one cannot invest directly in an index. Past performance is no guarantee of future results. The comments, opinions, and estimates contained in this document are based on, or derived from publicly available information from sources that Bache s Global Commodities Group believes to be reliable. We do not guarantee their accuracy. This information is provided for informational purposes only and sets forth our views as of this date. The underlying assumptions, and these views are subject to change. There is no guarantee that the views expressed will be realized. Bache Commodities Group from time to time, issues reports based on fundamentals, such as expected trends in supply and demand, as well as reports based on technical factors, such as price and volume movements. Since such reports rely upon different criteria, there may be instances when their conclusions are not in concert. Information for inclusion in, or for use in, the calculation of the Index is obtained from sources whose accuracy is believed to be reliable but which may be subject to errors in data sources. Copyright 2009. The Rock logo, BCI, and Bache Commodity Index are service marks of The Prudential Company of America and its affiliates. The Prudential Insurance Company of America is a subsidiary of Prudential Financial Inc., a company incorporated and with its principal place of business in the United States. Prudential Financial is not affiliated in any manner with Prudential plc, a company incorporated in the United Kingdom. The methodology of, and intellectual property rights in, the Bache Commodity Index SM are proprietary to, and owned by, PFDS Holdings, LLC and may be covered by one or more pending patent applications. Notes regarding the returns shown on the previous pages: 1) Returns reflected assume the 91-day Treasury bill rate earned on securities investments. While this rate will serve as the securities benchmark for program investors, it should be noted that the actual rate of return on securities portfolios may be above or below this rate. 2) The returns also reflect only the price performance of the BCI, not the performance of any actual account or group of accounts traded pursuant to the BCI. Accordingly, these returns are hypothetical in nature in that they were calculated without regard to the risks of loss ordinarily associated with actual trading. 3) The returns do not reflect the costs ordinarily associated with an actual BCI investment account.