Your Money: Limit exposure to commodity funds

Retail investors are better off betting on diversified fund in the domestic & international markets

International funds focused on commodities/natural resources have rallied sharply over the past one year. These returns are much higher than the single-digit returns given by Indian benchmark indices such as the Sensex and the Nifty (7.81 and 8.96 per cent, respectively). Experts, however, warn that investors tempted to invest in these funds should be aware of the risks that commodity-focused funds carry.

The stimulus programmes launched by central banks after the global financial crisis resulted in a rally in commodities, which peaked towards the end of 2011. Thereafter, a downturn began, owing primarily to the slowdown in Chinese demand. In 2016, however, the commodities and natural energy space witnessed a recovery. “Improving demand from China and expectations of increase in infrastructure spending in the run-up to the US presidential election are some factors responsible for the rally in the commodities space over the past one year,” says Anil Ghelani, senior vice-president, DSP BlackRock Investment Managers.

As for the rally in gold funds, he says: “These funds rallied over the past year on account of tempered expectations of US Fed rate hikes, and the political uncertainty arising out of Brexit, US presidential election, and so on.” 

Energy stocks rallied in 2016 due to two factors: The slow rise in the price of crude oil throughout most parts of the year, driven by numerous attempts at production cuts by the Organization of the Petroleum Exporting Countries (Opec), and the cartel finally agreeing in November 2016 to the first production cuts since 2008. Second, sentiment received a boost in the December 2016 quarter due to US President-elect Donald Trump’s promise to help energy companies by reducing regulation and encouraging more drilling.

Customers, tempted to invest in these funds, should remember a good part of the rally may already be behind them. “With crude oil having already risen to around $55 per barrel, there might not be much room left for it to rise further. At about $60 competition from shale comes in which puts a cap on further upside. For metals, it is hard to expect a prolonged rally at a time of tepid global growth,” says Kunal Bajaj, founder & chief executive of Clearfunds.com, a Sebi-registered online investment advisor. 

Investors should also bear in mind that the commodities/natural resources sector tends to have deep and prolonged bull and bear cycles. When demand and prices are rising, companies begin to add new production or mining capacity, which is a time-taking process. Sometimes, by the time these capacities come online, demand may have already slumped as industries that use their produce cut consumption to reduce raw material costs. 

So, capacities lie idle till the time the next up-cycle begins. Note that returns from most of these funds have been poor over the past five years.  

Gold tends to do well in times of uncertainty. Indian investors should certainly have a 10-15 per cent allocation to gold in their portfolios but through sovereign gold bonds or gold exchange-traded funds (ETFs).  

Experts suggest sector funds, whether in India or abroad, should not be a core holding for retail investors. “A mix of large, flexi and small-cap funds achieves the required sector diversification, and helps avoid the volatility that comes with buying a sector-specific fund,” says Bajaj.

Only high net worth investors who already have a well-diversified domestic and international portfolio and have a clear view on the commodities/natural resources space should invest in these funds.