- Date : 22/07/2021
- Read: 5 mins
Learn everything you need to know about investing in commodities funds.
Trading in commodities has been occurring around the world since centuries. It all started with hedging the exposure in farm produce with a forward contract. Lately, more people have been speculating in the commodity market with the help of derivatives.
As with equity mutual funds, one can take exposure to a basket of commodities with the help of commodity funds, thereby reducing the risk of exposure. Commodity funds primarily invest in such a basket of commodities.
Bear in mind that any changes in the price of the individual commodities has a direct impact on the value of the fund. For example, a gold exchange traded fund (ETF) provides you exposure to the fluctuations in the price of gold.
Types of commodity funds
- Natural resources funds: These funds primarily invest in companies that have direct exposure to natural resources like oil, gold, silver and other renewable energy companies like solar and wind energy.
- Basic true commodity funds: These funds have major exposure in metals i.e. physical assets.
- Future funds: The fund manager of a future fund takes bets on future trading of these commodities. These are among the riskiest assets in a commodity funds investment.
- Combination funds: These follow a combined strategy of the above commodity funds. It takes a balanced approach as it diversifies across future funds (high risk) and basic true funds (low risk).
- Index funds: These are passively managed funds where one directly buys the commodity on the standard prevailing rates based on the benchmark.
Benefits of investing in commodity funds
- Diversification: Adding a commodity exposure to the overall investment portfolio gives diversification benefit along with equity and bonds.
- Inflation hedge: Commodities are physical assets that generally increase in price with the overall inflation in the country. Commodities are thus a perfect hedge against inflation.
- Professional guidance: These funds are managed by finance professionals and hence have a better chance of making profits as compared to retail investors.
- Flexibility: Commodity funds are tenure-agnostic; i.e. the investor can invest in these funds for their short-term needs as well as long-term needs.
- Protection against volatility: Commodities such as gold and silver are considered to be less volatile options compared to the equity market. Whenever there is a correction in the equity market, gold and silver have tended to outperform all the asset classes. So, it proves to be a good hedge against market volatility.
Related: What is F&O in stocks and indices?
Risks associated with commodities
- Global demand and supply: Commodities are freely traded globally, and the price of these commodities are decided by the demand and supply in the world. There is a high risk that if there is a geopolitical issue in the importing country, there would be a mismatch in the demand-supply economic force and the price would drastically come down, and vice versa.
- Rate fluctuation: There is a higher fluctuation of rates in lesser known assets like renewable energy. This is because of lack of price discovery in the market for these commodities, which can lead to irrational pricing and higher volatility and lesser liquidity for these commodities specially.
Why investing in commodities is different from direct investment/mutual funds?
Let us take the example of gold as an investment. Indians have been active consumers of gold for decades, or even centuries. However, given the risk of theft and making charges, physical gold is now less preferred. The alternative is commodity funds like gold ETFs, which allow you to get the same exposure to gold price but electronically.
One can invest in gold ETFs with a minimum investment of 1 gm of gold So, even middle-income people can now make regular investments in gold without having a lot of money handy.
Related: Simple ways in which you can diversify your financial portfolio
Top performing commodity funds
|Name of fund||Annualised returns (over 1 year) as on 28th June 2021|
|ICICI Prudential Commodities Fund – Regular Plan||149.28%|
|DSP Natural Resources and New Energy Fund – Regular Plan - Growth||96.18%|
|Tata Resources and Energy Fund - Growth||76.23%|
|Aditya Birla Sun Life Commodity Equities Fund - Regular Plan - Global Agri Plan - Growth||57.95%|
Who can invest in commodity funds?
Prices of commodities can change overnight, and the markets can be volatile. These funds do not guarantee fixed returns; the returns can fluctuate based on the actual market prices. So, commodity funds are best suited for investors with a long-term investment horizon and a higher risk tolerance. Potential investors must equip themselves with the knowledge of the fund as well their investment strategy.