Investing in commodities through mutual funds

When global developments — be it the novel coronovirus (COVID–19) crisis, or the killing of an Iranian military personal by the US — stir international markets for commodities like gold and crude oil, the ripples are felt not only by the users and suppliers of the commodities themselves, but also those who view commodities as an investible asset class.

Increasing global interest, coupled with media focus and instant and universal access to market news, has made the Indian public look at commodities with special interest.

Besides, the 'financialization' of commodities, with availability of financial instruments such as futures, options and ETFs on commodities, has made commodity investment easier than was possible earlier.

Yet, the reach of commodities is still limited, and large sections of potential investors who are otherwise willing and interested in this asset class are often unaware of the modalities of participating in commodity markets through financial instruments. What has, therefore, been needed for a long time, is the presence of expert entities who could do this on behalf of the investing public.

These entities need to be accessible to even the small investors, who would trust them with their hard-earned money, and also be under tight regulation of the market regulator. In other words, the public has long been looking forward to presence of mutual funds in the commodity derivatives market.

Investing in commodities through mutual funds was not possible even a year back, till SEBI amended SEBI (Mutual Funds) Regulations, permitting mutual funds to participate in Exchange Traded Commodity Derivatives (ETCD).

Subsequently, SEBI Custodial Regulations were amended making way for custodians to provide custodial services in goods. Based on these amendments, SEBI permitted custodial services in select commodities.

The stage being set from the regulatory angle, it was only a matter of time before asset management companies (AMCs) began designing and offering schemes embedding commodity derivatives.

An AMC has just launched one such scheme on multiple asset classes, including commodity derivatives, becoming the first AMC to do so. It is learnt that several more schemes with commodity derivatives, by many other AMCs are also in the offing.

Several unique propositions. Commodities, by their very nature can ‘inflation-proof investors’ savings. Because of their pro-cyclic nature, commodity prices move together with macroeconomic growth and inflation. Commodity investors can, therefore, offset or hedge against possible decline in the value of their savings due to increase in commodity prices.

Besides, commodities typically have a low correlation with other asset classes, and therefore can be excellent portfolio diversifiers. As commodity fundamentals, which impact their prices, are often very different from the fundamentals of other asset classes, returns from commodity investments have historically been less correlated with returns from stocks and bonds.

The diversification benefit is best captured through the risk-adjusted returns of portfolios which include commodities. Several independent research studies have shown that an investor who holds a portfolio of stocks and bonds, an addition of commodities, (primarily in the form of commodity derivatives), distinctly improves the portfolio's risk-adjusted returns, compared to when commodities are not included.

Finally, the appeal of commodities to the Indian investing public lies in the way they relate to this asset class. Indians have traditionally invested in non-financial assets such as bullion, land, etc.

Hence, investing in commodities emerges as a natural choice for the less sophisticated Indian investors who look out for a safe haven to park their investible surplus, in a sector they can easily relate to and which mirrors their traditional investment culture.

With mutual funds now operating in the Indian commodity derivatives market, commodity investment, and the associated benefits as noted above, has now become easier and more accessible to the common investor.

Globally, about $1 trillion is held by various fund houses in commodity-based instruments, demonstrating global investors' appetite for commodities.

Given the popularity and proliferation of mutual funds in the Indian market, they can be the most effective medium for enabling Indian investors to access a new asset class, providing them unique benefits and creating wealth for them along the way.