The global economy was in an exuberant phase from 2003 to 2007, and demand for dominant industrial metals, such as copper, iron, zinc and nickel amongst others, went up several times. Miners blossomed and they started ramping up their capacities expecting boom to continue for several years to come.

But the aftermath of the U.S. subprime mortgage crisis, depicted a bearing on commodity prices, demand dampened, and since then the commodity market has been suffering their worst.

The year 2015, too, ended on a bumpy road with fall in prices of major commodities. But the uncertainty surrounding the global economy – with a wobbly economic growth reported by the U.S. (at some instance), slowdown in China, remorse economic conditions in Japan, and Greece's long-festering – led gold exhibiting sheen. And when the historic event of 'Brexit' was declared, on June 24, 2016, the precious yellow metal scaled to a 2-year high. Amidst this scenario, the accommodative monetary policy stance adopted by the central banks of developed economies have also been supportive for gold, as it's perceived to be a reserve currency or a safe haven. But with the recent comments from U.S. Federal Reserve officials -- increasing bets on an interest rate hike the end this year (due to signs of economic vigour showed by the U.S. economy) -- there are chances that even gold may lose some lustre as the greenback gets stronger due to the monetary policy action.

 

Similarly, with concerns about oil production freeze crude oil price has been moving in the band of US $40-50 per barrel. The Organization of the Petroleum Exporting Countries (OPEC) is meeting to review its production strategy in September and till then crude oil price is expected to stay firm.

Amidst such a backdrop, let's evaluate how commodity funds – launched during the exuberant times with pomp by some fund houses not anticipating the turbulence ahead– have fared. It is noteworthy that some fund houses as a strategy launched commodity funds oriented at investing largely in equities of producers of commodities in India, while some mandating to tap opportunities existing in international markets. Some took form as feeder's funds, investing in offshore funds of the same fund house.
 

Report card: Risk-return trade-off of Commodity Funds vs. Diversified Equity Funds

Scheme Name	YTD	1 Year	3 Years	5 Years	SD Annualised	Beta	Sharpe Ratio
SBI Magnum Comma Fund-Reg(G)	45.29	23.09	23.04	5.15	12.29	0.20	-0.02
Birla SL CEF-Global Agri-Reg(G)	9.95	-1.34	4.82	8.36	12.01	0.16	-0.13
DSPBR World Agriculture Fund-Reg(G)	7.31	-0.63	0.05	-	17.81	0.22	-0.18
DSPBR World Energy Fund-Reg(G)	24.29	7.90	-4.36	4.40	36.42	-0.36	0.07
DSPBR World Gold Fund-Reg(G)	186.97	76.68	4.46	-4.17	27.74	0.12	-0.13
DSPBR World Mining Fund-Reg(G)	85.63	25.43	-10.89	-8.10	41.32	-0.37	0.07
Kotak World Gold Fund(G)	205.64	78.81	3.54	-5.23	21.30	1.16	0.20
Category Average of Commodity Funds	80.73	29.99	2.95	0.07	24.13	0.16	-0.02
Category Average of Diversified Equity Funds	15.66	6.49	26.63	16.27	16.59	1.03	0.28
S&P BSE 200	0.04	5.46	19.91	12.80	15.48	1.00	0.19

(NAV data is as on August 22, 2016. Standard Deviation and Sharpe ratio is calculated over a 3-Yr period. Risk-free rate is assumed to be 7.38%)
*Category average has been calculated taking into account the peers above
(Source: ACF MF, PersonalFN Research)
Being thematic in nature, these funds have exposed investors high risk (measured in terms of SD Annualised) compared to diversified equity funds while clocking returns. But the risk-adjusted returns (denoted by Sharpe Ratio), reflects that the risk-return trade-off has not been worth it compared to diversified equity funds. Simply put, for the amount of risks commodity funds exposed their investors to, they haven't been rewarded adequately. On the 3-year time frame, the CAGR for category average of commodity funds is mere 3% as against 16% CAGR for category average of diversified equity funds.

Commodity funds have exhibited high volatility and dismal performance.

 

Commodity Market Outlook:
The delayed rate hike by U.S. Federal Reserve, which encouraged investors to commodity market, will result in loss of steam once normalisation of interest begins to happen. Metals may consolidate and may move lower as demand for industrial metals remains soft with the slowdown in China and restructuring of its economy. Coming to precious metals; the sheen for silver will depend on global industrial activity, since silver is mainly an industrial commodity. Gold, which is considered a reserve currency may show a corrective, if indeed the Federal Reserve proceeds towards to normalisation of policy rates. But for India, there would be cyclicality in the offing with the onset of festive and wedding season during the year-end. India is the world's second largest gold consumer and jewellers have started building their inventory. At the same time, demand for gold in China too is expected to increase due to upcoming mid-autumn festival in September. Also, until times when global uncertainty prevails, gold will be perceived as a safe haven.

The outlook for crude oil is, on the upside, hinged on the policy action of OPEC and global demand dynamics.

Farm prices are expected to remain high, except for wheat, which has had higher production.

To conclude...
The fortune of a commodity fund is dependent on three important factors:

• Policy framework for a particular sector within the theme;
• International commodity prices; and
• Currency market

Also, although factors driving hard and soft commodities are different and their demand-supply trends too vary to a great extent, most of the commodities are cyclical in nature.

It is vital to note that, thematic funds may generate envious returns when the theme or underlying sectors are witnessing or expected to witness rapid growth. But they hardly find proponents when the momentum fizzles and funds start performing miserably. PersonalFN has always believed that thematic and sectorial funds are extremely risky investment propositions for this very reason.

PersonalFN believes that cyclicality of commodities makes commodity funds risky. Since many of these funds invest outside India through a feeder fund form, currency movement may also affect the return potential of such funds to a great extent. PersonalFN is of the view that investors would be better-off if they avoid such fads and stay with diversified equity mutual funds. They might not quench your excitement of trying out new investment alternatives, but they may do a lot better than sectorial and thematic funds over a longer duration. What matters is the right selection.

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