How do Mutual Funds invest in Commodities?

Mutual funds are an investment vehicle that pools money from multiple investors and invests in a variety of asset classes, including stocks, bonds, and commodities. Investing in commodities helps investors broaden their investment options, and mutual funds invest in commodities through three specific routes:

1. Physical Route for Gold and Silver

Investors can invest in gold and silver funds through a mutual fund vehicle called an exchange-traded fund (ETF). These funds hold physical gold and silver, giving investors exposure to the underlying commodity's price movement. One other possible choice is to invest through Multi Asset Funds or Fund of Funds.

2. Listed Commodity Companies

Mutual fund schemes can also invest in commodities through shares of publicly traded commodity companies. For example, investing in oil and natural gas companies provides exposure to oil & gas sector as a commodity, while investing in aluminium producers would give exposure to aluminium. However, these investments may not move by exactly as much as the movement of the underlying commodity. In other words, the share prices of the oil and natural gas, and aluminium companies may move on account of other factors other than the underlying commodity they produce.

3. Exchange-Traded Commodity Derivatives (ETCDs)

Only certain types of mutual funds are allowed to participate in exchange-traded commodity derivatives (ETCDs), subject to limits. ETCDs are financial instruments that track the performance of a commodity or commodity index. For example, a gold ETCD would track the price of gold. By investing in ETCDs, mutual funds can gain exposure to commodities without having to physically own them. (see here for SEBI guidelines).

Benefits of Investing in Commodities through Mutual Funds route

Investing in commodities through mutual funds route offers several benefits:

1. Diversification: Commodities have low correlation with other asset classes, such as stocks and bonds. Investing in commodities through mutual funds can help diversify a portfolio and reduce overall risk.
2. Mutual fund Convenience: To illustrate, Gold ETFs invest in physical gold, providing investors with an opportunity to invest in gold without the hassle of owning and storing physical gold.
3. Purity: To illustrate, Gold ETFs hold gold complying with good delivery norms as specified by the London Bullion Market Association. (99.5% fineness or above)
4. Liquidity: Investors can trade ETF units easily on the exchange during market trading hours. Fund of Funds investors can transact at end of day NAV on a daily basis. All this is done easily without the end investor having to handle the physical gold themselves.
5. Low Cost: To illustrate, Gold ETFs and Fund of Funds are low cost investment avenues to invest in Gold.

Conclusion

Certain mutual fund schemes offer investors a convenient way to invest in commodities. With three different routes of investment, mutual funds can invest in commodities through physical holdings, listed commodity companies, and ETCDs. While currently no Indian mutual fund invests solely in ETCDs, Gold and Silver ETFs only invest in the commodities and not hold stocks of commodity companies. Investing in commodities through mutual funds offers diversification, professional management, and liquidity among other benefits. However, investors should carefully consider their investment goals, risk tolerance, and investment horizon before investing in mutual fund schemes that invest in commodities.

The information contained in this document is for general purposes only and not an investment advice. Readers should seek professional advice before taking any investment related decisions.

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