What are Commodity Funds – Types, Benefits And Returns of Commodity Mutual Funds
Commodities are raw materials used to make finished products such as automobiles, machinery, etc. The prices of commodities used to make finished products go through their own economic cycles based on the demand and supply of commodities. You can participate in the growth story of commodities in two ways: buying and selling these commodities directly or investing in the shares of companies producing commodities. A commodity mutual fund gives you an opportunity to participate in the growth stories of companies that produce commodities. This blog will focus on what are commodity funds – Types, benefits, and returns of commodity mutual funds.
What is a commodity fund?
A commodity mutual fund, just like a sectoral fund, is an open-ended mutual fund scheme that invests its money in the shares of companies engaged in the production of commodities. As per SEBI guidelines, a sectoral fund (a commodity fund in this case) has to invest a minimum of 80% of its total assets in equity and equity-related instruments of companies engaged in a specific sector (shares of companies engaged in the production of commodities in this case).
Commodity funds are also known as metals funds or mining funds. They invest in the shares of companies engaged in the production of various commodities such as:
- Shares of aluminium producing companies such as Hindalco, Nalco, etc.
- Shares of steel producing companies such as Tata Steel, SAIL, etc.
- Shares of iron ore producing companies such as NMDC etc.
- Shares of zinc producing companies such as Hindustan Zinc etc.
- Shares of oil producing companies such as ONGC, OIL, etc.
- Shares of Vedanta Limited, which is involved in the production of various commodities such as crude oil, zinc, aluminium, etc.
Now that we understand the commodity fund meaning let us see how a commodity fund works.
How does a commodity fund work?
A commodity fund raises money from investors during the new fund offering (NFO) period. The NFO documents mention the scheme objectives, investment philosophy, the risks involved, minimum investment amount, etc. in the NFO documents. Based on the above information, investors can decide whether they would like to invest.
Once the NFO closes, the fund manager deploys the money as per the scheme objectives. The investors are allotted the scheme units in proportion to their investment. The fund house declares the scheme's net asset value (NAV) at the end of every business day. The NAV moves up and down based on the scheme's underlying securities valuation. An investor's profit or loss depends on the difference between the current NAV and the price at which they bought the units.
Who should invest in commodity funds?
Commodity funds carry very high risk. Their returns depend on the performance of shares of commodity companies. The performance of shares of commodity companies broadly depends on the price performance of the underlying commodities such as aluminium, copper, iron ore, steel, etc.
The pricing of commodities mainly depends on the demand and supply of these commodities. When the demand is more than the supply, the prices of commodities go up. Similarly, when the supply is more than the demand, the prices of commodities go down.
There are a lot of variables that go into the demand and supply of commodities and their prices. It is a complex task for a fund manager to determine the future outlook for commodity prices. Hence, commodity funds are recommended for investors with an aggressive risk appetite.
The prices of commodities move in cycles and depend on the global economy's outlook. If an investor invests in a commodity fund at the bottom of an economic downturn or the start of an economic upturn, they can get good returns. However, calling a bottom or the peak is not an easy task for any investor. Hence, an investor should consider the systematic investment plan (SIP) option.
Performance of commodity funds
|Scheme name||AUM (Rs. crores)||1-year||3-years||5-years|
|Tata Resources & Energy Fund||185||4.65%||18.47%||18.27%|
|SBI Magnum COMMA Fund||470||34.29%||27.18%||17.05%|
|DSP Natural Resources and New Energy Fund||783||37.20%||21.12%||14.31%|
|Aditya Birla Sun Life Commodity Equities Fund||17||30.37%||20.19%||13.17%|
|ICICI Prudential Commodities Fund||688||49.35%||NA||NA|
How to invest in commodity funds according to your investment plan
While investing, an individual should follow asset allocation. They should diversify their investments in various asset classes such as equity, debt, gold, real estate, etc. An investor should further diversify within each asset class. For example, the major portion of the equity allocation can be invested in a mix of diversified equity funds such as large, mid, and small-cap equity funds. A small portion of the equity allocation can be invested in sectoral and thematic funds such as commodity mutual funds. As commodity mutual funds carry a higher risk than diversified equity funds, their exposure should be limited.