Understanding commodity funds
Commodity mutual funds invest in commodities like agricultural products and raw materials. Although India has a mature and diversified commodity market, a few investors only invest in goods as an asset class while diversifying their portfolio. Here we will discuss commodity funds meaning, types, and benefits of investing in commodity mutual funds.
What are commodity mutual funds?
Before we discuss commodity mutual funds, it is better to understand what a commodity is.
Commodities are any raw materials traded for another good of the same value. Gold, petroleum, agricultural products, and energy are some goods bought and sold daily. These commodities are traded for their demand as consumer items or commercial values. The commodity market is well-developed and governed by demand and prices. Hence, investing in commodities can deliver profit opportunities. A commodity fund tracks the price of a commodity, and its returns depend on the underlying asset’s performance.
For example, a fund can track gold. So, the returns from the funds are similar to the changes in the gold price in the market.
Commodity funds can also invest in company stocks involved in manufacturing these goods.
Despite massive profit opportunities, retail participation is scanty in the commodity market. So, these commodity mutual funds are an excellent way for retail and small investors to participate in the commodity market and offer good diversification in the portfolio.
Types of commodity mutual funds
Around the world, commodity funds invest in various goods. These are linked to underlying assets such as commodities and company stocks involved in manufacturing these products. Commodity funds are categorised below to help investors pick the right one.
Basic/true commodity funds
These funds predominantly invest in naturally occurring commodities like metals.
Natural resource funds
These funds track the stocks of companies dealing with natural resources like natural gas, mineral, oil, petroleum, and others.
Future funds
The futures funds are the riskiest of all the commodity mutual funds because of the high volatility of futures. These funds invest in commodity futures, and the NAV of these funds may rise or fall dramatically depending on the fund manager’s decision.
Combination funds
As their name suggests, these funds invest in commodities and commodity futures to attract higher returns. On the risk spectrum, these funds are mid-way from commodity mutual funds and commodity futures funds.
Index funds
The index funds invest in commodity indexes and generate the same returns. The aim is to track the index with minimum tracking error. These passively managed funds buy commodities at standard rates based on the market benchmark.
Benefits of investing in commodity mutual funds
Diversification of the portfolio
Investing in different mutual funds targeting various asset classes helps lower market risk. Investors can invest in commodity mutual funds for portfolio diversification and to get exposure in the commodity market to enhance the profitability of their investments.
Hedge against inflation
Commodity prices rise with inflation. Hence, investing in commodities offers effective hedging against rising inflation in the market. Commodity funds
Planned investment
Another benefit of investing in the goods market through mutual funds is professional fund managers who are knowledgeable of the commodity market and can make the best investment decisions. Even new investors can boost their investments by investing in the commodity market through the managed funds route.
Investment flexibility
Investors can adopt an investment style or select a fund depending on their short-term and long-term goals. One must choose funds based on personal taste, as different funds are designed to meet varied purposes.
Protection against volatility
It is a general concept that the commodity market is volatile. But, items like gold and silver are less volatile than stocks. Hence, demand for gold investment increases when the stock market is volatile. These metals offer significantly higher returns even when the market is down.
Things to remember while investing in commodity funds
After understanding the commodity fund definition and its types, here are a few factors to remember if you want to invest in commodity mutual funds.
- • One requires a basic understanding of the commodity market to make sound decisions. Several economic and political variables affect commodity prices in the market, which makes it highly volatile.
- • Commodity investment can be precarious as the returns are not assured.
- • Asset values often fluctuate more, which may cause the NAV value to rise and fall more drastically.
- • Futures commodity funds are riskier than other funds because of the highly volatile nature of futures. The outcome of these funds depends on the expertise and decision-making of the fund manager, and the profit can diverge dramatically from your targets.
- • Energy stocks make up the majority of commodity indices. Hence, the fund’s performance will depend on the performance of energy stocks, which can impact the outcome of your investment.
Who should invest?
The purpose of creating different mutual funds is to cater to the specific investment needs of investors. These funds invest in commodities, futures, and stocks of companies manufacturing these goods. Investors must understand the risks associated with commodity mutual funds before investing.
Commodity fund managers don’t offer any guarantee on the fund’s returns. Hence, these funds are unsuitable for investors seeking assured returns on investment. These funds are riskier because commodity price fluctuates drastically. Hence, these funds are suitable for investors who are okay with taking risks or have a specific time frame to get returns.
It requires more market research to generate returns from commodity investment. Hence, investors will benefit by educating themselves.
Final words
You can explore various investment options in the commodity market now that you have learned about commodity funds definition. These funds will allow you to invest in multiple underlying assets and diversify your exposure. But these funds also carry the risks typical of the commodity market. Hence, a thorough understanding of the asset and the market is essential.
