While the commodity derivatives market in India has grown over the years, the rate of growth has not been along expected lines. Retail participation, like in the equity market, has been based more on ‘hot tips’ and with limited knowledge and understanding of the market dynamics. Such participation usually comes to an abrupt end with investors burning a huge hole in their pockets.
In the equity segment, High Net Worth Investors (HNIs) and retail investors have increasingly been finding a comfort zone amongst mutual funds. Can this relative equity success story now be replicated in the commodities segment too? After setting the guideline for REITs, which provide investors the opportunity to get a slice of the realty pie sans an obscenely large capital outlay, the markets regulator, Securities and Exchange Board of India (SEBI), has now trained its guns on helping to expand the commodity derivatives market.
With this objective in mind, SEBI has recently approved transactions by mutual funds and portfolio managers in this potent segment.
Hence, alongside some Alternative Investment Funds, which were already permitted to participate in the commodity derivatives segment, mutual funds and portfolio managers too will be permitted to participate in the segment. They will thus be permitted to deal with goods received in delivery against physical settlement of such contracts, whenever it is necessary. However, ‘sensitive commodities’ as indicated by SEBI will remain out of bounds.
Furthermore, like in the case of equities, the mutual funds will need to appoint a qualified fund manager with adequate experience in the commodities market. They will also need to appoint a custodian to have custody of underlying goods in case of physical settlement of such contracts.
So, how will these changes benefit the retail investors? For starters, even for the slightly better equipped retail investors, the commodities market universe in India has really revolved around trading in the precious metals segment, namely in gold and silver.
Even among mutual fund investors, the only commodity proxy available for investing has been gold, as mutual funds offered them Gold Fund-of-Funds, where the pluses included a low-cost entry, Systematic Investment Plan facility and better liquidity.
Commodity cycles had to be played by investing in mutual funds and reposing faith in the fund manager’s ability to do so by buying or selling listed stocks from the segment as a kind of proxy play on the underlying commodity’s price movements.
With its latest initiative, SEBI has opened the doors, not only to deepen the depth of the commodity derivatives market, but also for retail investors to try and duplicate their equity success story using the same mutual fund vehicle via Exchange Traded Funds offerings.
A word of caution though is due. Notwithstanding expertise and experience, any derivatives market is fraught with higher risk, and in the commodities market, this risk cannot be understated.
Hence, while it is a welcome development, investors would do well to participate in the inevitable ETF offerings from the mutual funds: not blindly, but based on a calibration of their risk profile and sound professional advise.