These funds give you an opportunity to make some money whenever commodity prices flare up
It's been ages since consumers have been crying themselves hoarse over the stubbornly high prices of commodities. The unacceptable level of inflation has blown their financial planning strategies off course as soaring expenses burn a huge hole in their pockets. So how would you like it if you were given an opportunity to make the culprits — commodities in this case — contribute to your kitty instead of eroding it?
Enter Commodity Funds
This is where some financial advisors say commodity mutual funds come into the picture. Although, the option of commodity futures exists, it involves big money and you may not want to risk such a huge sum in a volatile market. Instead, you can consider commodity funds. These funds invest in commodities-related companies such as metals and oil, in India or abroad. The logic is that these companies will clock profits whenever commodity prices see a spike. As an investor, you stand to indirectly benefit from this price rise by opting for a commodity fund, which invest in several such companies.
Most of these funds relate to international commodity stocks either through the direct or feeder fund route. The one-year performance of most of such funds has ranged between 15% and 36%. The current buzz for international investing, coupled with the rather insipid one-year performance of the broad Indian indices (around 7%) is inducing funds to market such schemes more aggressively. Even within these, it is primarily gold feeder funds which are more prominent.
A Case For Commodity Funds
Commodity prices are expected to harden across the world, given the outlook on inflation. Indian investors can take advantage of rising commodity prices by investing in select feeder funds which invest in a basket of commodity-oriented stocks internationally. Commodity funds help an investor participate in commodity-led inflation. India is a net importer of commodities, so in general, Indian assets are negatively correlated with inflation. When the investor allocates a part of the portfolio to commodity funds, he partly hedges his portfolio. If commodity prices go up, inflation would in-crease. Increase in commodity prices would result in positive returns on commodity funds. Increase in inflation would result in fall in Indian equity and Indian fixed portfolio. In the past one year, commodity funds have outperformed Indian equities and fixed income as an increase in commodity prices have resulted in 20%-plus returns from diversified commodity funds while Indian equities/fixed income have give single-digit returns. Since commodity-led inflation would continue to be high in the medium term, an investor should allocate part of his portfolio to commodity funds.
Agro Funds & Commodity Funds
There are certain mutual funds which do not invest in just commodities but the entire supply chain, which helps you diversify the risk, say experts. Commodity prices have risen significantly in past eight months ended February 2011. Cotton prices have gone up by 146%, sugar by 84% and wheat by 54.
There have been weather-related supply shocks in 2008 and 2010 which caused price spikes. Furthermore, according to the Food and Agriculture Organisation (FAO), food prices have risen to an all-time high following the severe flooding in Australia this year.
With food and soft commodity prices at or near record highs, caution is required from retail investors who are considering entering into a fund which concentrates only on commodities as it could be a risky proposition given that they may be entering at the wrong point of the cycle.
Hence, an investor should ideally consider a fund which focuses on the entire agricultural business, which includes fertilisers, pesticides and the entire supply chain. Agriculture is highly undervalued today and it is way cheaper than metals.
Despite the Green Revolution in 1965, India has not undertaken any major investment in agriculture. China is the only exception to the global trend.
Therefore, agriculture, as a sector, has a huge potential and investors must tap this resource. Investors can look at a time horizon of 2-3 years.
Get The Right Mix
While the concept seems exciting, you need to look carefully before jumping at the seemingly foolproof opportunity. Since most of these involve international commodity stocks, an investor has to grapple with price fluctuations at two levels: the underlying commodity as well as the stock market scenario in that particular country. In addition, there are currency fluctuations and unfavourable tax treatment to deal with. Investing in these funds calls for very good sense of market timing. In fact, I think the best time to buy these is when they are totally ignored and not being marketed at all. Of course, it would help if you are clued in to the underlying commodity's fundamentals too. Even if you are convinced about their utility, remember, they should be used to supplement your basic investment plan which should comprise diversified, large-cap equity funds.
Thematic funds are a very broad asset class comprising sector funds, market-cap specific funds, international diversified funds, international commodity funds etc. If we club all of these into the 'satellite category' investors could hold up to 20-25% in such funds. However, as a general rule, you must not invest in something you are not able to comprehend.
Especially, beware of any hard-selling indulged in by funds or distributors because such practices increase at the most inopportune time for the investor i.e. when the particular theme outperforms over a short period of time.
Commodity funds have a definite advantage of diversification — you are exposed to a wide range of companies in different commodities rather than volatility of individual commodities.
However, weigh your options carefully and do keep a sharp eye on the costs involved. For this reason alone it may be prudent to avoid Fund-of-Funds and opt for funds directly managed from India itself. However, it must be seen in conjunction with the ability of the fund manager or the fund house too
