DBLCI Mean Reversion (MR) Index - Rationale and Index Mechanism

Rationale and Index Mechanism

The DBLCI-Mean Reversion is the only index which dynamically changes its weights according to whether a commodity is considered cheap or expensive. When all the commodities are within 5% of their five-year averages, the weights will automatically revert to the weights of the base index, the DBLCI. The rationale behind the construction of the DBCLI-MR is to exploit the tendency of commodity prices to trade within wide, but, defined ranges because:

• As prices of commodities rise, new production capacity is brought on line to benefit from higher prices.
• More supply becomes available from alternative sources previously considered uneconomic.
• In oil markets, quota systems that attempt to control supply come under strain as the rewards for cheating rise.
• As prices rise, the demand for the commodity will begin to fall as it faces competition from cheaper sources.

The net effect is to keep commodity prices bound around their long run average price.

In essence the DBLCI-MR is a strategy to buy low and sell high. It therefore tends to take profits gradually in a bull run and re-invest those proceeds into cheaper commodities. One benefit of this approach is that the DBLCI-MR tends to extract volatility from the index since as commodity prices rally so to does volatility. evidence suggests that portfolios comprising past losers tend to outperform past winners and vice versa over time, see Hersh Shefrin, Beyond Greed and Fear, Harvard Business School, 2000. In fact this has been a recurring theme of commodity markets over the past few years. We find that it has been common for a commodity to be at the bottom of the league table in terms of total returns in one year, to be close to the top in the following year only to reverse these gains in the next 12 month period.