Unlike equity, debt, gold and real estate that retail investors have traditionally been comfortable with, investing in the commodity asset class is not so common in India. With the Securities and Exchange Board of India (Sebi) notifying guidelines for mutual funds to invest in exchange-traded commodity derivatives (ETCDs) in May, investors now have the option to include commodities in their portfolios through a familiar instrument that comes with the advantage of being professionally managed.

Until now, investors could take indirect exposure to the sector by buying stocks of commodity companies. The more adventurous could invest directly in commodity futures on commodity exchanges. However, most retail investors stayed away as trading in commodity futures needs significant knowledge, time and money. Sebi’s guidelines seek to bring commodity investing to this category of investors.

The case for commodities

Historically, there has been little correlation between the movements of this asset class and that of traditional assets such as equity and debt. This translates into better diversification, with portfolios that hold commodities being able to generate more stable returns as compared to one which holds a single asset such as equity.

A study by Axis Mutual Fund showed that a portfolio with 90% exposure to equity and 10% to commodity in the period between 2007 and 2019 delivered a return similar to that of a pure equity portfolio but with much lower volatility.

What the guidelines say

In its 21 May 2019 circular, Sebi said mutual funds could invest in commodities only through ETCDs, and couldn’t take exposure to a physical commodity except in the case of gold ETFs (exchange-traded funds). If the funds have to take delivery of the underlying goods in case of physical settlement of contracts, then it has to be disposed within a period of 30 days, the notification said.

Sebi has allowed mutual funds to participate in ETCDs in hybrid and multi-asset allocation schemes only. In multi-asset allocation schemes, the exposure to ETCDs has been restricted to 30% of the net asset value (NAV) and in hybrid schemes to 10% of the NAV. The exposure a scheme can take to a single commodity has been capped at 10%. These limits do not apply to gold ETFs and gold funds.

What these guidelines translate into for investors is a conservative exposure to commodities as a means to bring stability to portfolio returns. A 30% allocation to commodities in a portfolio is seen as adequate in a scheme for this purpose. In case of hybrid schemes, the token of exposure of 10% may give some flavour of commodities but not necessarily the benefits of diversification. The cap of 10% in a single commodity, except in the case of gold limits the risks for the investor. “The liquidity in commodity markets in India is quite lop-sided. Once you go beyond the top six or seven commodities for which there are globally benchmarked prices, like gold, oil and metals, liquidity drops off significantly," said Ashwin Patni, head products at Axis Mutual Fund, pointing out to the practical limitations of having dedicated commodity funds with a 10% cap on individual commodities.

“For the mutual fund industry, the low hanging fruit from allowing investments in ETCDs is that gold ETFs are likely to become more competitive again," he added.

Mutual fund investors in India are likely to get the opportunity to invest in commodity through multi-asset allocation schemes sooner than exchange-traded funds that track a commodity index do. In a circular on 18 June 2019, Sebi laid out the guidelines for construction of commodity indices and commodity ETFs may only be launched once the index providers make available these robust multi-commodity indices. But fund houses have already lined up multi-asset allocation schemes with exposure to commodities.

Mint’s take

The one commodity that most India investors relate to is gold. Exposure to commodities beyond gold will open another avenue to earn a higher return. “We will consider these funds to give exposure to investors in one more asset class. It may give an extra edge to a portfolio," said Renu Maheshwari, chief executive officer and principal advisor at Finscholarz Wealth Managers LLP, a financial planning firm. “We will need to see how these portfolios are constructed before we decide the role they will play in the long term," she added.

“The role of commodities as physical assets is to give you participation in the real economy and to insulate you to some extent from turmoil in the financial system," said Patni. “Even a modest allocation to commodity can bring down volatility sharply without affecting the returns.You get a smoother ride for the same return," he added.

When these products are available, investors may consider them as a way to bring some stability to the returns rather than as a way to benefit from expected price movements in commodities. As such they have to be long-term investments and not short-term speculative transactions. The multi-asset allocation funds will be a more efficient vehicle than the hybrid schemes where the exposure is too small to matter. The requirement in Sebi’s guidelines for a dedicated fund manager for commodities will add to the safety feature for investors.

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