Commodity Mutual Funds

Every investor is searching for ways to diversify their portfolio and yield more returns in unpredictable financial markets. And one of the biggest avenues in recent years is mutual funds. Commodity mutual funds invest uniquely in diversified commodities such as agricultural products, energy, and metals. This investment allows you to invest in a wider class of assets to hedge against inflation and market volatility. The commodity margin calculator is an essential tool to evaluate potential margins in such investments.

In this article, we will look in depth at commodity mutual funds and their pros and cons, as well as how they fit into the ecosystem of your investment strategy.

What Are Commodity Mutual Funds?

Let's understand what commodities are. Commodity refers to those types of goods that are usually traded for their value. Examples include gold, silver, sugar, oil, and natural gas. Market demand, supply dynamics, geopolitical events, and economic conditions influence their prices.

Commodity mutual funds are specially created to invest in specific commodities or related assets. Investors are given the opportunity to participate in commodity markets and earn returns based on changes in the prices of the underlying commodities through these MFs.

Commodity mutual funds are investment avenues that attempt to track or replicate returns from commodities or commodity trading indices. They are designed to make diversified exposure to commodity markets. Such funds offer the ability for portfolio diversification, hedging against inflation, and access to lucrative markets to investors.

Types of Commodity Mutual Funds

Based on the underlying assets, the commodity mutual funds are classified into:

Benefits of Investing in Commodity Mutual Funds

When looking for mutual fund investment avenues with better return potential, commodity mutual funds emerge as a successful option without directly getting involved in online commodity trading. It offers the following benefits:

• Lower Correlation with Equities and Fixed Income - The prices of most commodities tend to move in a different direction than those of equities and bonds. This would mean that when the values of the latter two head south, those of commodities might appreciate and vice versa. Adding a commodity fund to your portfolio will lead to a reduction in overall portfolio risk, along with an improvement in the risk-adjusted return profile.
  
• Historically Appreciating Assets - Commodities usually appreciate with inflation, which helps to protect the purchasing power of your investment. Since inflation depletes the value of money, commodities hold their value if not appreciated, acting as a hedge against inflation.
  
• Supply and Demand Dynamics - Commodity prices depend upon the demand for and supply of the respective commodity. If high demand and low supply of a commodity are found, then the returns from the investment in a commodity fund could be very high. Losses can also occur if supply and demand dynamics go against expectations.
  
• Lower Minimum Investments - Commodity investing typically involves large sums of money. However, in the case of commodity funds, the minimum investment requirements are relatively low, thus opening this sector to many more investors.

Risks of Investing in Commodity Mutual Funds

While commodity funds boast several good options for investors, looking at their risks will help you decide how to invest in them. A few of the critical risks to watch out for are given below:

• High Volatility - Commodities prices are never stable and tend to see wide swings based on changes in weather, geopolitics, or even supply and demand.
  
• Lack of transparency in strategy - Commodity funds, especially actively managed ones, can be pretty complex and not very transparent. Investors might find it fairly difficult to comprehend how fund managers make decisions and how much risk is involved in those decisions.
  
• Currency fluctuations - If commodity funds are invested in assets whose prices are quoted in foreign currencies, then fluctuations in the exchange rate will impact the return from the fund.

Popular Commodities in Indian Mutual Funds

Historically, the performance and volatility of gold, silver, and energy commodities have made them very prominent in the Indian mutual fund market. Below is a brief overview of some popular commodities and their role in mutual funds:

Gold

Gold is commonly considered one of those "safe-haven" assets because it usually gains value and stabilises when the economy is falling apart or in states of high inflation. Gold has generally performed well in history; hence, this metal serves as the primary tool for investments by people looking for shelter during economic storms. Its role as a reservoir of value, combined with its relatively low correlation with other asset classes, makes it increasingly valuable for diversification purposes. The chart below shows volatility in gold prices:

Popular Funds

• SBI Gold Fund: It is a scheme that essentially invests in gold bullion and replicates the performance of gold. The investment in the said fund would, therefore, provide exposure to the price movements of gold without the hassles of buying and storing physical gold.
• HDFC Gold Fund: It is a transparent and performance-oriented fund that usually invests in gold to represent gold price performance and to offer investors an easy way to expose them to gold.

Silver

Though similar to gold in their investment appeal, the price of silver is more volatile. This, in turn, can suggest higher potential gains and risks. Its price relies on industrial demand and investment tendencies that can create price swings even more wild than gold. Here is how the price of silver varied in the past year:

Popular Funds

• SBI Silver Fund - The investment objective of this scheme is to provide returns linked with the silver price performance. It allows investing in silver more conveniently rather than investing in it physically.
  
• ICICI Prudential Silver ETF - This open-ended exchange-traded fund provides liquidity and flexibility. It creates a portfolio mainly benchmarked to silver and will get listed on the exchange for trading. Hence, this fund helps the investor get exposure to the silver market with much efficiency.

Energy Commodities (Oil, Gas)

Being naturally and significantly volatile, energy commodities significantly influence the performance of mutual funds. Their prices might change due to geopolitical events, dynamics of demand and supply, and changing global energy policies. The fluctuation can sometimes result in immense gains or massive losses to the funds invested in energy commodities.

Key Funds

• UTI Energy Fund - This fund invests in a diversified portfolio of energy-related assets, including oil and gas companies, to capitalise on the growth and performance of the sector.
  
• Kotak Commodities Fund - The scheme provides exposure to a broad array of commodities to benefit from the movements in the prices of various segments of the energy sector and capture emerging opportunities.

Who Should Invest in Commodity Funds?

Commodity funds can enhance your portfolio, but they are not for everyone. Here's how to figure out who might consider parking their money in these funds:

• Investors Looking for Diversification - More often than not, commodities move independently from those of stocks and bonds. Adding a commodity fund to your portfolio can diversify your risk and improve overall risk-adjusted return.
  
• Inflation Protection - During periods of inflation, commodities generally increase in value. One of the better ways to protect your purchasing power over time is with commodity funds.
  
• Sophisticated Investor - Actively managed commodity futures funds can be quite complex, as a strong understanding of futures contracts and the factors that affect the prices of commodities is usually required. Such funds will, therefore, best suit experienced investors who can comprehend the dynamics within the commodity markets.

Why Should You Invest in Commodity Mutual Funds?

Investing in commodity mutual funds has become increasingly popular, and for good reason. These funds offer several compelling benefits that appeal to investors seeking to enhance their portfolios. However, it's essential to weigh the associated risks as well.

Portfolio Diversification

Every investor looks to diversify their portfolio across various asset classes. Commodity mutual funds provide an additional layer of diversification, allowing you to spread your investments across different commodity markets.

Protection Against Market Fluctuations

Unlike most asset classes, certain commodities, such as gold and silver, are less influenced by market trends. This means they can deliver favourable returns regardless of the broader market’s performance, providing a stable investment during uncertain times.

Expert Fund Management

In India, commodity mutual funds are managed by seasoned fund managers with deep expertise in commodity markets. This professional management can offer investors a strategic edge by navigating the complexities of commodity investments.

Inflation Hedge

Commodity mutual funds typically offer returns in line with global market movements, making them a good hedge against inflation. As prices rise, the value of your investment tends to hold or appreciate, safeguarding your purchasing power.

Flexible Investment Tenure

Whether you're planning for short-term or long-term financial goals, commodity mutual funds can help you achieve them. They offer flexibility in terms of tenure, making them suitable for a variety of investment horizons.

Diverse Options

Commodity mutual funds come with a broad range of investment options, helping you tailor your portfolio to meet specific financial objectives.

Risks to Consider

The performance of commodities is influenced by macroeconomic, political, and social factors, which can introduce certain risks. As with any investment, it's important to understand these risks thoroughly before committing to commodity funds.

Remember, as an investor, it’s crucial to have a good understanding of how commodities work. The NAV (Net Asset Value) of these funds may fluctuate with market changes, and returns are not guaranteed. Conducting thorough research and assessing potential risks is key to making informed investment decisions.

Best Commodity Mutual Funds in India

Here are some of the best-performing commodity mutual funds you can consider for portfolio diversification:

Conclusion

Commodity mutual funds add value to a diversified portfolio of investors in pursuit of capital appreciation and hedging against inflation. On the other hand, active investment management has to consider risks, such as volatility of prices, regulatory changes, and counterparty risk. Do your homework before investing in a commodity mutual fund by researching the fund's history, investment goals, and risk tolerance.

Want to get started with commodity investments? Explore the Choice platform to identify the best avenues for investment for diversification and optimal returns.