Commodity Mutual Funds

Table of Contents

Every day, different commodities are traded around the world that is highly valued for their commercial value and consumer demand. These commodities include things like coffee, food grains, precious metals, coffee, and precious stones, as well as petroleum products, gold, and precious stones. These commodities are traded on domestic and international markets, which provide investors with the opportunity to invest in such commodities. The commodities traded are subject to demand and market prices, which control the trade of these goods.

In general, the use of commodities to hedge inflation risk and diversify portfolios is regarded as an important portfolio management factor. Direct investment in commodities or commodity derivatives requires investors to have substantial assets and/or knowledge of these commodities or their respective derivative markets. In recent years, as an alternative to direct investment, investors have increasingly turned to commodity-based mutual funds.

Although there is no SEBI recognized category of mutual funds called commodity mutual funds, however, SEBI through its circulr number SEBI/HO/IMD/DF2/CIR/P/2019/65 has allowed mutual funds to invest in exchange-traded commodity derivatives and in gold and silver. Practically, mutual funds in India which have the term commodity in their name are either (a) hybrid mutual funds or (b) gold/silver ETFs.

How Do Commodity Funds Work?

Commodity funds function similarly to other types of mutual funds, in which the pooled funds of investors are invested in a particular financial instrument and the returns generated are distributed proportionally. These financial instruments in commodity funds include commodities such as gold or silver or exchange traded commodity dertivates of commodities like petroleum, sugar, metals, etc.

If the commodity is sold at a higher price, any increase in the price of these commodities results in a profit for the investors. These funds require slightly more financial knowledge than other mutual funds in order to comprehend their operation. Before investing in commodity funds, it is usually recommended that amateur investors seek assistance from an expert or a mutual fund advisor.

Commodities or commodity-based investments, such as commodity mutual funds, are frequently added to portfolios as an inflation hedge and to diversify conventional stock and bond portfolios. The value of these mutual funds has increased significantly over the past few years. Through indirect participation in the commodities market, commodity mutual funds offer investors a simple way to diversify their portfolios ( due to initial margin and daily settlement requirements, it is much more difficult for many investors to invest directly in the futures market).

Commodity mutual funds may be risky for investors who are just beginning to invest in mutual funds. These require knowledge of commodities and their risk profile. Commodity mutual funds can be added to a portfolio in order to achieve diversification and risk-adjusted returns once the investor is comfortable with these concepts.

Features of Commodity Mutual Funds India

The following are the features of investing in commodity mutual funds:

Flexibility: There are numerous categories and subcategories of commodity mutual funds. As a result, investors have several options to choose from. Additionally, there are funds ideal for both short- and long-term investment horizons. One can choose an appropriate fund for investment based on their financial objective and time horizon.

Hedge Against Inflation: Most commodity funds act as an inflation hedge, delivering returns that correspond to global trends. With inflation, commodity prices rise. Thus, these are among the few assets that benefit from inflation.

Risks: Generally, commodity mutual funds are less volatile than equity mutual funds. Nevertheless, they are not risk-free. Geopolitical activities have an effect on commodity funds. For instance, if a country imports coal from another nation. Certain conflicts between the two countries have the potential to affect coal prices.

Diversification: Commodity funds are an excellent means of diversifying a portfolio. They tend to reduce the risks associated with a portfolio because of their inverse relationship to the stock market. Moreover, since they are also excellent hedging investments, including them in the portfolio may help individuals generate better risk returns.

Expert Fund Management: Usually, commodity trading requires extensive experience. Through commodity mutual funds, individuals can gain exposure to the commodities market with relative ease. With his expertise, the fund manager will make a continuous effort to increase returns for investors. Consequently, investing in commodity funds is one of the simplest ways to participate in the commodities market and diversify your portfolio. Additionally, professional fund managers will assist you in generating significant returns.

Growth: Prices of commodities fluctuate based on demand and supply. When the demand for a commodity is high but the supply is low, the price of that commodity rises. Consequently, the potential for financial growth is substantial. In other words, an investment in such a commodity will produce substantial returns.

Types Of Commodity Mutual Funds

Based on the investment objective and strategy of the fund, commodity funds are divided into various subcategories. Although there are no fixed differentiation criteria, some of the various types of commodity mutual funds include:

Natural Resources Funds: Natural resources funds invest in a variety of companies that trade in gold, silver, oil, petrochemicals, etc. The performance of natural resources funds is directly influenced by commodity prices. With the advancement of technology, investments in renewable energy sources such as wind power are also now feasible.

True/ Basic Commodity Funds: True or basic commodity funds invest in naturally occurring physical assets, such as metals.

Future Funds: Futures-based mutual funds invest in commodities via futures contracts. Investing in a futures contract does not necessitate the purchase of the underlying commodity. Due to the high volatility of futures contracts, these funds carry the highest risk of all commodity funds. The fund manager of a futures fund determines the commodity’s futures trading. Depending on the fund manager’s choice, the NAV of these funds could significantly increase or decrease.

Combination Funds: Combination funds, as their name suggests, invest in both basic commodities and commodity futures. Since they invest in both futures and basic commodities, their risk exposure is balanced. Compared to basic commodities, futures are high-risk investments.

Index Funds: Index funds track an index that comprises commodities. The objective is to track the index with as little error as possible. Since a fund tracks an index, it is an investment that is passively managed. The fund purchases commodities at standard rates in accordance with the benchmark.

The Advantages Of Investing In Commodity Funds

Commodity funds are quite popular among both new and seasoned investors. Due to its favourable qualities, it is not surprising that it is so popular. These funds attract huge investments. They provide their investors with a wide range of perks and benefits. However, one needs to be mindful of the risks involved. By spreading the investment among several different stocks, portfolio diversification greatly minimizes the risk of failure with a single unsuccessful investment.

Protection from Volatility: As opposed to other commodities, silver and gold are less prone to market trends. Even when the market is down, they still offer significant returns due to their great worth.

Strategic Advantage: Expert management assists in gaining the strategic advantage that comes from market professionals having first-hand knowledge of the markets and commodities.

Protection Against Inflation: Generally, these funds offer returns that are consistent with changes in the global market, acting as a hedge against inflation.

Flexibility In Investments: Through commodity funds, investors can always achieve their short- or long-term investing objectives.

Multiple Options: Commodity funds offer a wide range of investment options, making it easier for investors to find investments that fit their needs.

Risk: Depending on the commodities and how they perform on the global market, the risk associated with commodity funds can range from geopolitical to market performance. Commodity fund investing is quite complicated and risky, thus it calls for a deep understanding of the commodities and the market.

Investors need to familiarize themselves with how the commodity markets operate. There are no specific guidelines for fixed or guaranteed returns because these funds are quite susceptible to market changes. The dangers of investing in such commodity funds must be considered by investors.

Conclusion

A commodity fund is a mutual fund in which the investment in commodities is managed by a fund manager. Investor returns are generated based on how the chosen commodity performs in the market. For many individuals, investing in a commodity fund is preferable to investing directly in commodities because the fund manager who oversees the fund’s investments is a professional with experience dealing with commodities. Due to the popularity of gold in India and its use as an inflation hedge, the majority of Indian asset management firms have introduced commodity funds that only trade in gold.

Frequently Asked Questions (FAQs)

What are Commodity Funds?

Commodity funds are funds that invest primarily in commodities like gold, oil, and livestock. They also invest in commodity futures and options. Some commodity funds also invest in company stocks, including gold funds that invest in the stocks of gold mining companies.

As its name suggests, a commodity market includes a variety of products, including gold, oil, and various agricultural products. The performance of the economy and the forces of demand and supply influence the prices of commodities. Instability in commodity prices can provide investors with leverage that helps in revenue generation.

For example, the value of a fund that uses gold as its commodity fluctuates with the price of gold. Thus, the scheme’s returns are directly related to gold price fluctuations. Moreover, commodity funds may also invest in the companies that produce the commodities.

Who should invest in commodity funds?

Commodity trading requires in-depth market and product knowledge, and beginners are prone to errors that could end up costing them a lot of money. Individuals who lack this expertise may choose commodity funds, which are typically managed by expert fund managers. In addition, commodity funds fluctuate with the market and are susceptible to fluctuations, making them an occasionally risky investment option. Investors who are willing to assume this risk might think about investing in them.

Fund managers do not provide a fixed-guarantee for these funds’ returns. As a result, commodity funds are unsuitable for investors seeking fixed returns or guaranteed growth. Additionally, the term of a particular fund might not be able to produce the returns anticipated by investors (due to market conditions), making this product unsuitable for people looking for returns within a specific time frame. Commodity funds are a wise investment for people who don’t mind taking risks and who don’t have a set time period in mind for returns when these factors are taken into account. Additionally, patience can be an added virtue when investing in them, making these funds ideal for individuals with funds who are seeking to diversify their portfolio.

What risks are associated with investing in a Commodity Fund?

Investment in commodity funds carries its own set of inherent risks. While this investment provides the ideal opportunity to diversify a portfolio dominated by capital markets, it also increases the portfolio’s risk exposure. As the price of commodities is highly volatile, a price decline may result in substantial losses for investors. Multiple factors, including geopolitical instability, natural disasters, currency instability, and market sentiment, can cause price fluctuations.

Prior to investing in commodity funds, it is advisable to seek guidance from an expert, as the inherent risk is high and the selection of the right commodity at the right time is crucial.

What is the importance of investing in commodity funds?

Every day, numerous high-value commodities are traded on the domestic and international markets. By investing in commodity funds, investors can profit from this lucrative market without requiring a comprehensive understanding and knowledge of it. Generally, there has been little correlation between commodity market fluctuations and those of traditional markets such as stocks and bonds. This would result in a greater degree of diversification, as portfolios containing commodities would provide more stable returns.

Let us assume that there is an excess of coffee production during a given year, causing prices to decrease. This would harm the prices of coffee-related stocks and reduce the value of the portfolio. In this case, an experienced fund manager can anticipate the situation by selling futures on coffee on the commodity market. In contrast to the more established equity market, India’s commodity market is still in its development stage. Consequently, there are more pricing inefficiencies and more opportunities to generate profits. Strong networks and access to high-quality research allow mutual funds to capitalize on these opportunities.

What are some of the different commodities available in the market?

Some of the types are:

- Metal: Along with precious metals like gold, silver, and platinum, a wide range of metals, including those used in manufacturing and construction such as iron, copper, aluminium, and nickel, are available for trading in the market.

- Energy goods: Energy goods used in homes and industries are traded in large quantities. This consists of natural gas and oils.

- Agriculture-related products: The commodity market sees trade in a wide range of agricultural and livestock products. Examples include sugar, cocoa, cotton, spices, grains, oilseeds, pulses, eggs, and feedstock.

- Environmental goods: This category includes renewable energy sources etc.

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