What are Commodity Funds? Invest in Commodity Funds
It is a well-known fact that trade and commerce have played a significant role in shaping our lives. Commodities have enabled trade to take place since centuries. The significance of a commodity is defined by the amount of money it is bought for, signifying its goods or services. Commodities play a vital role in the era of this marathon of trades and commerce cycles while obeying its participants and generating notable finances. It is especially important to understand and observe the commodities, their function in keeping the trade cycle running, and the process of commodities generating returns for their respective investors.
Now, let us understand and acknowledge the aspects of the commodity funds, their types, benefits, and advantages of investment.
First, let us understand the term commodity in terms of finance.
What are Commodities in terms of finance?
A commodity is nothing but goods, gold, bulk stocks, precious objects, possessions, assets, raw materials, and consumer products like- food grains, supplementals, tea, coffee and sugar. A commodity is a good which is purchased for another good for an alike value and fair price. A consumer's demand and an associated fair commercial value leads to a practice of trading commodities. The term 'commodities' also represents financial products like- currency, stock and bond. A producer cannot add or extract a value of a commodity that lies in actual form.
Commodities are further distinguished into two categories that are:
Agri-Commodity
Agri-commodity is an agriculture-based commodity that is endorsed through practicing and cultivating the farm. Most commodities are essential crops and animals which are produced or planted. Grains, livestock, and dairy provide a source of food for people and animals across the globe.
Non-Agri Commodity
Commodities that have been extracted from earth or available naturally for livelihood are non-agricultural commodities. Non-agri commodities like gold, metals, crude oil, gasoline, and natural gas etc. are commonly traded.
What are commodity funds? How do they work?
Throughout the globe, there are various and different commodities that are traded on a daily basis. The highly priced commodities valued for their commercial value and consumer demand range from petroleum products, gold, precious metals and food grains. A commodity fund is a mutual fund that invests in the trade of a specific commodity. This allows investors to trade domestically and internationally and offer them a chance to make investments in such commodities. These funds specialize in the investment in a particular product.
This helps an investor to dive into an opportunity to earn returns on their investments. The trade of commodities is subjective to demand and the market prices that supervise the trade of such commodities. Fluctuations while practicing the trade may also influence direct bearing on the returns earned on transacting. There are risks as well as advantages and benefits while investing in commodity mutual funds. Earlier investors were required a thorough knowledge and understanding of the functioning of the commodities while acknowledging the risks and benefits.
In India, the majority of the asset management companies have driven commodity funds that specifically trade with gold as it acts as a fence against inflation and is profoundly valued.
How does commodity trade practice work?
In India, commodities are bought on the officially registered commodity trading exchanges. Usually, trades take place in the spot market or futures markets. The commodity trading happens instantly in spot markets in exchange for cash while in future markets, it happens electronically while settling the contracts in hard cash. There are six dominant commodity trading exchanges in India, i.e.: -
- Indian Commodity Exchange- ICE
- National Commodity and Derivatives Exchange-NCDEX
- Multi Commodity Exchange-MCE
- National Multi Commodity Exchange-NMCE
- Ace Derivatives Exchange- ACE
- The Universal Commodity Exchange-UCE
Investment in commodities is performed through futures and options.
1. Future Contract- It is an agreement through which one can buy or sell any particular specific quantity of the commodity at a fixed price at any period of time and date.
2. Options Contract- It is a contract between a buyer and seller where a buyer buys the right to buy or sell the stock shares or commodity at a defined period of time.
Well, it is considered risky and inaccessible for a layman to trade-in options. Hence, commodity mutual funds are favorable to trade-in
Types of Commodity Funds
Commodity funds have a diverse number of subcategories that depend upon the type of investment strategy and investment aspiration.
1. Natural Resource Funds: These funds invest the compilation of corpus in the companies or organizations which have a business connected with natural resources such as minerals, petroleum, oil, gold, etc. The achievement of these funds is immediately dependent on the price of commodities with which the business is connected.
2. Basic/True Commodity Funds: These funds are named basic because the commodities are instantly bought by the merged corpus of the fund. These funds essentially invest in naturally occurring commodities like metals.
3. Future Funds: These funds are acknowledged as the most endangered commodity fund as they are directed to significant variations according to the market rates. The fund supervisor of a future fund looks up for future trading. The NAV of these funds can decrease distinctly but can also produce notable gains if the precise calls are performed.
4. Combination Funds: As the name presents, these funds support a combined strategy of investing in commodity futures and basic commodities. The commodity future occupies high risk while the basic commodity investing controls the fickle.
5. Index Funds: The index commodity funds are quietly regulated mutual funds in which the investments are directly used to buy the commodity on the standard persuading the rates based on the benchmark.
Benefits of investing in commodity funds
Investing in commodities can present investors with an assortment, a fence against inflation, and a good number of positive returns. Investors may endure volatility when their investments pursue a single commodity or one division of the economy. Supply, demand, and cartography affect the fluctuation of commodity prices.
• Hedge against inflation- When there is high inflation, prices of commodities rise at a level with the affecting inflation rate or with the global market alteration. Hence, investing in commodities plays as a hedge against inflation as it contributes to investor protection against the decreased purchasing strength of a currency.
• Protection Against the Market Fluctuations- Investment in commodities reduces the volatility of the portfolio. The reason being, whenever the equity market falls, the price of the commodities rises and when the equity market is on the rise, commodity value falls. Thus, the investment in commodity balances out the fluctuations in the market.
• The Flexibility of Investment Objective- Commodity mutual funds are capable of accomplishing short term and long term goals. Commodity futures can be utilized for various tenure to accomplish the investment purpose conveniently.
• Diversification of Portfolio- Adding a commodity fund to the portfolio can increase the change in the portfolio. Diversification can lessen the risk equated and can encourage constant growth despite the market conditions.
• Risk- Commodity funds are less likely to fluctuate, unlike equity funds. These funds can succeed in market uncertainty and favour to move slowly. The risk connected with commodity mutual funds is often due to geopolitical activities.
The following table shows some of the top performing commodity mutual funds in India.
| Scheme Name | 1 Year Return | 3 Year Return | 5 Year Return |
|---|---|---|---|
| Axis Gold Fund | -3.16% | 13.82% | 7.99% |
| HDFC Gold Fund | -4.29% | 13.21% | 8.34% |
| Kotak Gold Fund | -3.80% | 13.24% | 8.92% |
| SBI Gold Fund | -4.45% | 13.25% | 8.20% |
Tax Implications on an investor for investing in commodity mutual funds in India.
• If the mutual fund units are sold after 3 years from the date of investment, gains are taxed at the rate of 20% after providing the benefit of inflation indexation.
• If the mutual fund units are sold within 3 years from the date of investment, entire amount of gain is added to the investors' income and taxed according to the applicable slab rate.
Conclusion
As commodity trading requires extensive knowledge about the commodity and the market conditions, investors who lack the knowledge can opt for commodity mutual funds. Commodity mutual funds are highly subjected to market risks and hence they do not guarantee fixed or secured returns. New investors entering this ring should take expert assistance for a more reliable investment experience. Commodity mutual funds offer hedge and therefore should not more than 10% of the portfolio of the investor.