There’s more good news for investors put off by the vagaries of the Indian stock markets and the current inflationary trends. In these tough times globally, commodities have been on their cyclical upswing and several leading Indian fund houses are set to launch schemes to make money for investors.
Commodity mutual funds are an interesting, and potentially rewarding, way to diversify an investment portfolio beyond stocks and bonds. That is because commodities are often viewed as a hedge against inflation; ie, the prices of commodities tend to rise in step with inflation. This movement trends to run counter to stock prices — which is an attribute that makes commodity mutual funds so attractive to many investors.
In general, commodities are defined as things that tend to come from the earth or are grown. This includes grains, minerals and metals, livestock, cotton, oils, sugar, coffee, and cocoa.
Commodities are traded in the spot market or in the form of futures contracts. Spot market trades are made for immediate delivery. For example, energy could be traded on the spot market and delivered immediately into the electrical network. When trading on the spot market, physical delivery of the commodity often takes place.
Commodities traded as futures are contracted for a “future” delivery date. Most investors in the commodity market trade in futures contracts and many of these contracts are sold before the contract expires. That means the average investor never takes physical delivery of the commodity itself, rather they are looking to make money on their investment through the changes in the commodity’s value over time.
Traditionally, many investors playing in the commodities futures market invest using a margin account. When using a margin account the investor might only need to invest five percent of the contract’s total worth to hold it. While this approach creates windfall profits for some, the added risk produces many losers too.
In the same way that traditional mutual funds allow investors to create portfolios of common stocks or bonds, commodity mutual funds give investors the option of adding commodities to their portfolio and limit the risk associated with the commodities market.
The market price of most stocks goes down when inflation is rising. There are several explanations for this, but the simplest has to do with the cost of borrowing. Inflation is usually associated with higher interest rates — and this makes borrowing more costly for a company. In turn, the increase in interest expense lowers earnings per share.
To leverage this inverse relationship between stock prices and commodities, the investor has two options. The first is to buy into commodity mutual funds as the hedge against inflation.
The Economic Times has quoted a study by Mirae Asset Management, whose Global Commodity Stocks Fund is currently open for subscription, which has found that the Rogers International Commodity Index (RICI) has outpaced most other emerging market indices including Sensex in different phases starting 1999. RICI, designed by Jim Rogers in 1998, is known as one of the most diverse commodity indices spanning 35 commodities from 11 international exchanges.
Only once did the Sensex manage to register better returns than RICI, when it jumped five times in the bull phase between 2003 and 2007. RICI, in the same corresponding period, registered a two-fold increase. However, the recent past has seen RICI outpacing other indices by an impressive margin. For instance, the Sensex has lost 38 per cent year-to-date, while RICI has gained over 25 percent.
Since Indian regulations do not permit mutual funds to invest directly in commodities, fund houses are going for schemes that invest in stocks of companies engaged in mining and other activities. As there are not many mining companies on the local bourses, most of these funds propose to invest in companies abroad.
ING Investment Management India was the first fund house to sight these opportunities. Last Monday, ING Mutual Fund launched its new scheme — ING Optimix Global Commodities Fund, an open-ended Fund of Funds scheme. The investment objective of the scheme is to achieve long-term capital growth by investing primarlly in units of global mutual funds which invests in commodity related securities. The new fund offer (NFO) opened on July 29 and closes on August 25.
The scheme will invest 65 percent-100 percent in global mutual funds, which invest in commodity related securities, zero percent-25 percent in debt funds an d money market funds, and upto 10 percent in money market securities.
The scheme offers two options viz Growth option and Dividend option, minimum initial investment is Rs5000. The scheme will charge entry load of 2.50 percent for investment below Rs5 crore.
HSBC MF is also reported to be preparing to launch a commodity-based fund. It’s Agri and Natural Resources Fund proposes to invest in companies which are involved in the agricultural sector.
Mirae Asset also recently filed its application with the market regulator to set up a global commodity stocks fund that will invest 65 percent of its corpus in stocks or mutual funds operating in the Asia-Pacific region and emerging markets.
Similarly, Tata Mutual Fund is proposing to launch a gold and precious metals fund that will invest in mining companies.
Most of the funds are planning to take a feeder-fund structure, whereby the fund will invest in a global fund that has a past track record. Globally, this theme has done quite well.
Gaurav Mashruwala, a financial planner, speaking to Business Standard, advised first time investors to start by investing two to five percent of their portfolio in such funds. They can then gradually increase it to 10-15 percent.
