A beginner’s guide to commodity mutual funds: Types, risks, and advantages

Accessing commodities directly can be complex and risky for small investors. This is where commodity mutual funds come into play. Commodity mutual fund schemes provide a convenient and structured way for Indian investors to gain exposure to the commodity markets. In this article, let’s understand what commodity mutual funds are, how they work, and the types of commodities funds available. We also discuss their advantages, the commodity funds’ returns, and the risks involved.

Table of contents

• What are commodity funds?
• How do commodity mutual funds work?
• Types of commodity funds
• Advantages of commodity mutual funds
• Why should you invest in commodity funds?
• Who should invest in commodity mutual funds?
• What are the risks associated with investing in commodity mutual fund schemes?
• Factors to consider when investing in commodity mutual funds

What are commodity funds?

Commodity mutual funds pool money from multiple investors to invest in assets related to commodities such as gold, oil, or agricultural products; commodity futures contracts; or commodity-based indices. The primary objective of commodity mutual fund schemes is to provide investors with an opportunity to gain exposure to the commodity markets without needing to trade directly in these volatile and complex assets.

How do commodity mutual funds work?

Commodity funds invest in physical commodities like gold, silver, or oil, or commodity-related assets like futures contracts and stocks of commodity-producing companies. The value of the commodity funds rises and falls based on the performance of the underlying assets—such as the price movements of gold, crude oil, or agricultural products.

Thus, commodity mutual funds aim to provide exposure to commodity markets, benefiting from price movements, and offering diversification and an inflation hedge for your investment portfolio.

Types of commodity funds

Commodity mutual funds can generally be categorised into three broad types:

• Single commodity funds: These commodity mutual fund schemes focus on a single commodity. For example, gold funds will invest primarily in gold, gold ETFs or gold-mining stocks.
• Multi-commodity funds: These funds invest in a diversified mix of commodities, such as agricultural products, metals, and energy resources.
• Commodity equity funds: These funds invest in stocks of companies that are involved in the production or trading of commodities. The performance of these funds is closely tied to the financial health of the companies they invest in.

Advantages of commodity mutual funds

• Portfolio diversification: Commodities tend to have a low correlation with traditional asset classes like equities and bonds. Adding commodities to a portfolio can help mitigate overall portfolio risk and provide diversification, especially during market volatility.
• Liquidity: Investors can redeem their investments in commodity mutual funds as and when needed. This is not always feasible with investing in physical commodities like gold or crude oil.
• Hedge against inflation: Commodities, especially gold, have historically been a strong hedge against inflation. When inflation rises, the value of currencies tends to fall, but commodity prices may increase.
• Exposure to global growth: Commodities are influenced by global economic growth. Investing in commodities allows investors to tap into the growth potential of emerging economies, particularly in industries like energy, agriculture, and metals.

Why should you invest in commodity funds?

Here are three reasons to invest in commodity funds:

• Portfolio diversification: Adding commodity mutual funds to your portfolio can cushion against market volatility, especially during stock market downturns.
• Hedge against Inflation: Commodities like gold, silver, and oil traditionally perform well during inflationary periods, which is the main reason why it can be suitable to invest in commodity mutual funds. Meaning, your investment in commodity mutual fund schemes can help shield your investment against inflation.
• Expert management: Commodity mutual funds are managed by professional fund managers who have in-depth knowledge of the commodity markets.

Who should invest in commodity mutual funds?

You can invest in commodity funds if:

• You have a higher risk tolerance since commodities can be volatile.
• You have a longer investment horizon.
• You seek to hedge against inflation.
• You are a high-net-worth individual who wants to diversify their holdings.

What are the risks associated with investing in commodity mutual fund schemes?

If you want to invest in commodity funds, here are the risks you should know about:

• Volatility: Commodity prices can be highly volatile, influenced by unpredictable factors like geopolitical events, weather conditions, and global supply-demand imbalances. This is why only investors with a higher risk tolerance should consider investing in commodity mutual funds.
• No income generation: Unlike stocks or bonds, commodities do not generate income like dividends or interest. You can view commodity funds’ returns as being more suitable for capital appreciation rather than regular income generation.
• Commodity market risk: Investing in commodity futures exposes investors to market risks associated with the underlying commodity, such as storage costs, rollover risks, and price fluctuations.

Factors to consider when investing in commodity mutual funds

If you want to invest in commodity funds, you must first clearly define your investment goals and investment horizons. Then, here are the other factors you need to consider:

• Fund objectives: Determine whether the fund's objectives align with your investment goals. Do you want to hedge against inflation, diversify your portfolio, or grow wealth? This will help you choose the right commodity mutual fund scheme.
• Expense ratio: Since higher fees can eat into net commodity funds’ returns, it is important to compare different commodity mutual fund schemes with similar objectives and choose the one with a relatively lower expense ratio.
• Market conditions: Monitor global economic conditions and commodity market trends before you invest in commodity funds. This is crucial because commodity prices are sensitive to geopolitical, economic, and environmental factors.

conclusion

In conclusion, commodity mutual funds offer Indian investors an opportunity to diversify their portfolios, hedge against inflation, and tap into the global growth of commodity sectors. With various commodity mutual fund schemes available, investors can choose funds that suit their risk appetite, financial goals, and investment horizon. However, they come with risks, including volatility and market fluctuations like any other mutual fund investment. You must understand these risks and consult a financial advisor before you invest in commodity funds.

FAQs:

What are commodities in a mutual fund?

Commodities in a mutual fund refer to physical assets like gold, silver, crude oil, or agricultural products. A commodity mutual fund invests in commodities or related instruments to diversify portfolios and provide the potential to earn inflation-beating returns in the long term.

Which commodity mutual fund is best?

There is no such thing as the best commodity mutual fund. The best commodity mutual fund schemes depend on the individual goals of the investor. However, gold and oil remain two of the most popular commodities for mutual fund investments. You can consult a financial advisor for personalised recommendations.

Can mutual funds hold commodities?

Yes, mutual funds can hold commodities indirectly by investing in commodity-related assets, such as commodity futures, commodity ETFs, or stocks of commodity-producing companies.

Is it good to invest in commodity funds?

Yes, investing in commodity mutual funds can offer the benefits of portfolio diversification and inflation hedging. However, investors must exercise caution while investing in commodity mutual fund schemes since they are characterised by higher volatility.

Which is better: Commodity or equity?

Equity investments offer long-term growth potential, while commodities provide inflation hedging and diversification. A suitable solution is a balanced portfolio with both equity and commodities since it can mitigate risks and optimise the return potential, depending on individual goals.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.