The Hindu Business Line : Caution on commodity MFs

COMMODITY DERIVATIVES ARE the flavour of the season, with much hype about the high returns from trading in commodity futures. Driven mainly by the nationwide online multi-commodity exchanges, in the last 12 months volumes in the futures section have soared to the Rs 3,000 crore-a-day mark. The potential is larger as the market is at a nascent stage. As of now only hedgers and, to some extent, speculators, including equity market players, have been participating. The fund flow is slow. But the entry of mutual funds can change all this. Everyone knew it was only a matter of time before fund managers re-examined their asset allocation plans to include new and emerging investment opportunities. Now, mutual funds are ready to invest in commodity derivatives. Commodity derivatives offer mutual funds one more avenue to invest.

There are synergies between equity and commodity markets that can be tapped. The relationship between commodity prices and the equity of commodity-based companies is well known. Market participants have begun, albeit in a small way, to take advantage of this relationship. There are reports of a dedicated fund for commodities. But will commodity-linked mutual funds succeed? Unlike the stock market, which has matured and is reasonably well understood, the commodity futures segment is just beginning to find its feet. Information flow in the commodity market, at least in India, is inadequate. Considering that mutual fund investment in even the so-called mature equity market is only a small part of the total investible funds, the level of interest in commodities is anybody's guess. It is unclear if fund managers are really ready, in terms of product and market knowledge, to manage the risks of investing in commodity derivatives, which are by no stretch of imagination a safe haven.

Along bear market in commodities running to years is not unknown. A study of the global price movements of major commodities in the last six years would show up the volatility and how vulnerable the Indian set up has been, given its increasing integration with the global market. While commodity derivatives may bring better returns, the effect of flow of large sums into commodities cannot be ignored. Speculative investment in commodities is sure to push up prices, a development unlikely to advance consumer welfare. The problem would be more acute with agricultural commodities that have a high weightage in the consumer price index.

The inadequate logistics and infrastructure facilities with the commodity exchanges are the other areas of concern. Equally important is the regulatory oversight of mutual fund investments. Mutual funds investing in gold futures may be a good bet for now as the Indian market truly tracks the global price movement and almost the entire domestic requirement is imported. But the same cannot be said of agricultural commodities. Clearly, subscribers to mutual funds have to take a call. The Commerce Ministry has set up a committee to examine the regulatory structure of the gold industry, and one of the terms of reference is to recommend measures to facilitate mutual funds to invest in the yellow metal. It may not be a bad idea to await the report of this panel.

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