Commodity Mutual Funds - Meaning, Types & Benefits

Commodity investment is gradually proving lucrative in India, and globally, as commodities are in demand everywhere. As the demand for commodities like gas, oil, and gold increases, investors view these as assets and believe they may have potentially positive prospects. If the commodities are not viable for some investors to buy, they may consider commodity mutual funds.  

Essentially, commodity funds invest in the trade and companies of particular commodities. Commodities are goods that represent the raw materials to make products. They are “primary agricultural products” or “primary products” and since they act as the backbone of production, they are potentially always in demand. As a result, commodities are considered the core of global markets as they play an integral role in production and consumption. If investors wish to be pivotal parts of the growth stories of commodity markets, they can invest in commodity mutual funds. Knowing the meaning of these funds, their distinctive types, and their characteristic advantages is essential as the first step toward investment.  

What are commodity funds?

The answer to the question, “What are commodity funds?” lies in grasping some basics about commodities themselves. Simply put, a commodity is a basic product, raw material, or primary agricultural source product that can be purchased and sold. Commodities may be considered resources to manufacture final products. Examples of common commodities are gold, natural gas, oil, wheat, coffee, and such. Typically, these products are considered uniform in standard and quality and can be interchangeable with any other products that are alike or similar.  

Commodities are the crux of many relevant industries that manufacture certain goods. Furthermore, commodity markets permit the exchange and trade of such goods with the prices of commodities being affected by key factors. These factors include supply and demand, economic trends, geopolitical variables, and the weather. Commodity mutual funds may be a consideration for those who want to partake in investment in commodities but cannot do so directly. Additionally, commodity markets offer you a chance to earn lucrative returns as trading commodities is a vital component of financial markets and a significant part of international investment and trade.  

Coming to commodity funds. These are mutual funds that primarily invest in commodities. For instance, any given commodity fund may pool investors’ money and invest in specific tangible assets like energy, metals, and agricultural products, or combinations of commodities. As with other mutual funds,  commodity funds are managed by professional and proficient fund managers who have a wealth of understanding of the commodity markets. They may buy and sell commodities to strategically manipulate the fund with the objective of maximising investors’ profits.  

Types of Commodity Funds 

The various types of commodity funds include the following:  

• Basic/True Commodity Mutual Funds: These funds invest in commodity futures contracts or physical commodities directly. They aim to offer investors returns that track the underlying commodities performance they hold closely.   

• Natural Resource Mutual Funds: These commodity mutual funds mainly invest in firms that are linked to the manufacturing and distribution of specific natural resources such as minerals, gas, and oil, amongst others. Commonly, they concentrate on the equity of companies producing resources rather than directly investing in contracts like commodities futures.  

• Index Mutual Funds: These are funds that are managed passively where fund managers use the assets of the funds to buy commodities at rates of the market. The commodities are bought based on an index or benchmark of commodities.  

• Futures Funds: In the domain of commodity funds, futures contracts are popular with investors. These funds invest in contracts of commodity futures where the commodity’s (represented in any contract in the fund) physical delivery takes place at a pre-fixed date. Considered potentially lucrative, these funds may pose a degree of risk due to price shifts, as losses occur in case prices fall.  

• Combination Commodity Funds: As the name suggests, some of the best commodity mutual funds invest in a blend of commodities. For instance, funds may expose investors to a mix of, oil and natural gas equities and futures commodity contracts. Consequently, investors get a more diversified investment approach compared to investing in a single commodity.  

Key Features of Commodity Funds 

Commodity mutual funds are of various types, and each has distinct qualities. When selecting any fund, investors should consider aligning funds with their investment goals and horizons, besides their risk profiles. However, there are some common features of commodity mutual funds to consider before investing. These are listed below:  

• Portfolio Diversification: Commodity funds can effectively diversify your financial portfolio as a broad range of commodity-linked instruments and commodities can be invested in. By investing in a varied array, you hedge your risk rather than betting on a single asset to maximise returns.  

• Transparent and Professional Management: Commodity fund houses provide investors with regular reports of the performance of their holdings and any new investments added to funds. Investors have full transparency and get professionally managed funds by expert fund managers who attempt to hedge losses and optimise gains.  

• Risk Mitigation and Hedging: Commodity funds tend to lessen your portfolio risk by distributing your investment across a variety of commodities. Hence, in case of volatility in prices, your overall portfolio is not potentially negatively affected. Risk in your portfolio is also hedged by commodity funds as commodities experience distinctive price shifts relative to other assets and securities, especially relative to traditional financial instruments. In times of inflation, commodity investment may be viewed as a safeguard.  

• Generation of Income: Commodity funds investing in commodity-producing companies may distribute dividends regularly, providing investors with a stream of income generation.  

• Choice of Investments: Commodity mutual funds offer you a wide investment arena, with a variety of commodity-related instruments and commodities. Additionally, investors have a choice of commodity industries and sectors and are free to enjoy options aligned with their financial goals, risk tolerance levels, and investment timeframe.  

• Price Volatility: Although commodities tend to be steady investments at the best of times, they are prone to price fluctuations. Key factors that may cause shifts in commodity prices comprise weather conditions, supply and demand elements, and geopolitical variables, depending on the commodity.  

Why invest in commodity mutual funds? 

After you know the answer to the often-asked question, “What are commodity mutual funds?”, you can decide to invest based on the advantages of such funds. These are described below:  

• Diversification and Inflation Hedge: Due to various kinds of commodities offering diversification in your portfolio, you get a hedge against price volatility as well as potential inflation. In this way, mitigating risk in your portfolio is effective with commodities.  

• High Return Potential: If investors are successful at timing the financial markets, commodity price volatility can be leveraged to deliver positive returns.  

• Professional Fund Management: Commodity mutual funds are managed and administered by fund managers who are experts in the industry. These fund managers take fund investment decisions that are aimed at yielding high gains and optimum fund performance. Furthermore, fund managers are savvy when it comes to complex commodity markets and this permits investors to enjoy hassle-free investments.  

• Specific Sector Access: Certain commodity funds emphasise particular sectors, such as precious metals or energy. Consequently, you can explore focused commodity industries without directly purchasing physical commodities and dealing with the concerns of purity (as in metals) or storage.  

Who should consider investing in commodity mutual funds? 

Commodity funds are versatile investment instruments for those investors looking for diversification in their financial portfolios. Additionally, such investors may potentially possess a tolerance for moderate to high risk, attempting to combat impending volatility in prices. Moreover, investors who wish to have an inflation hedge can consider commodity funds and those who want exposure to certain sectors may think of commodity mutual funds. Finally, if you are an investor with a long-term investment view, seek dividend payouts, and have an eye for speculative investment, commodity funds may be a suitable investment avenue.  

Conclusion

In the Indian universe of investment, commodity funds offer unique benefits to allocate capital so that it potentially grows. As with all investments, commodities and their prices are affected by several factors and may be prone to risks due to dynamic price movements. Nonetheless, commodity mutual funds may be considered a lucrative investment channel after investors do their due diligence research into commodities and assess their goals and risk profiles.