You will soon be able to invest in commodity derivatives through mutual funds.

The capital market regulator has been trying to encourage institutional investors to increase their participation in the commodities derivatives market for the past 2-3 years.

Finally, it’s ready with the framework.

SEBI has already permitted Alternative Investment Funds, Eligible Foreign Entities, and PMSs to invest in commodity derivatives.

In a circular dated 21 May  2019, the Securities and Exchange Board of India (SEBI) laid out the blueprint for mutual funds to invest in Exchange Traded Commodity Derivatives (ETCDs).

Can any mutual fund scheme invest in ETCDs?

No. The capital market regulator has permitted only hybrid schemes including multi-asset allocation schemes to invest in ETCDs. Hence, Conservative Hybrid Funds, Balanced Hybrid Funds, Aggressive Hybrid Funds, Dynamic Asset Allocation Funds, Multi-Asset Allocation Funds, Arbitrage Funds, and Equity Savings Funds will be able to invest in ETCDs.

If the existing schemes decide to invest in ETCDs, that will be considered a change in the fundamental attributes. In this case, the concerned mutual fund scheme will have to allow an exit window of 30 days to investors at the prevailing NAV without charging any exit load fee.

Moreover, mutual fund schemes investing in ETCDs will have to benchmark their performance against the appropriate benchmark.

Essence of the SEBI guidelines…

• Mutual funds shouldn’t invest in sensitive commodities.
• Except Gold ETFs investing in gold, no other mutual fund scheme should invest in physical goods.
• If a mutual fund scheme decides to go in for a physical settlement of ETCDs and as a result holds goods on its books, it shall dispose of the same within 30 days from the date of holding the physical goods.
• No mutual fund scheme shall have net short positions in ETCDs on any particular good, considering its positions in physical goods as well as ETCDs, at any point of time.
• Except for gold ETFs investing in ETCDs, all other schemes will cap their single goods exposure to 10% while investing in ETCDs.
• Except for multi-asset allocation schemes which are allowed to invest upto 30% of their net assets in ETCDs, other hybrid schemes will have to restrict their overall ETCD exposure to 10% of their net assets.
• In the case of Gold ETFs, the cumulative exposure to gold related instruments, i.e. Gold Deposit Scheme (GDS) of banks, Gold Monetization Scheme (GMS), and ETCD having gold as the underlying should not exceed 50% of net asset value of the scheme.
• Mutual funds must appoint a dedicated fund manager having required skills and experience in commodities market, including commodities derivative market.
• Investments of mutual funds are subject to the board approved investment and valuation policies in writing. Board of AMC and the board of trustee have to approve it.

Are mutual funds keen to invest in ETCDs is a moot question

 Compliance norms might add to the schemes’ costs. If mutual funds don’t find investment opportunities attractive enough to launch New Fund Offers (NFOs) or to make changes in the fundamental attributes of the existing funds, they may not be enthused about investing in ETCDs.

Reactions coming from the mutual fund industry are quite suggestive.

“Commodity derivatives is a volatile space on a standalone basis. So depending on the kind of appetite in the market for commodity exposure, mutual funds will decide to launch commodity-dedicated schemes”—Chirag Mehta, Senior Fund Manager, Quantum Mutual Fund (Source: moneycontrol.com)

Other experts believe, constraints on the physical delivery might deter mutual funds from launching NFOs focused on ETCDs. Nonetheless, some experts feel SEBI allowing mutual funds to invest in ETCDs is a welcome step from the diversification point of view.

What can investors do?

If you are a mutual fund investor, you must consider your financial goals, time horizon, and risk appetite before investing in mutual funds. Do not get carried away by the developments in the mutual fund industry. More than the asset allocation of mutual funds, your personalised asset allocation will decide how successful you are as an investor.

If the hybrid fund you have invested in decides to invest in ETCDs, carefully analyse if it has offered any clarity on the process it will follow and risk management practices it may employ. Unless you are satisfied with scheme’s disclosures in this regard, blindly continuing with the scheme even after the fundamental changes in the attributes can be detrimental to your portfolio.

Follow the same approach while investing in NFOs focused on investing in ETCDs. Only multi-asset allocation hybrid funds can help you diversify in a meaningful way since they are allowed to have a higher exposure to ETCDs, as compared to other hybrid schemes.

When selecting a mutual fund scheme for your portfolio, analyse all the available options on various quantitative and qualitative parameters.

This article first appeared on PersonalFN here.