Mutual funds to participate in commodities derivatives - will it help?

Some time back, SEBI issued a consultation paper inviting comments from the public on permitting mutual funds and portfolio managers to participate in commodity derivatives market. 

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The English translation is as under:

Some time back, SEBI issued a consultation paper inviting comments from the public on permitting mutual funds and portfolio managers to participate in commodity derivatives market.

Currently mutual funds are permitted to participate in equity and interest rate derivatives markets. Many funds have taken advantage of this provision by launching various products, e.g. arbitrage funds, dynamic funds and equity savings funds.

As per the present regulations, the only commodity that mutual funds can invest in is gold. Mutual funds have launched gold ETFs (Exchange Traded Funds). And gold savings funds.

The recent consultation paper issued by SEBI seeks to allow mutual funds to launch schemes not just investing in silver, but also many other commodities.

One of the highlights of the consultation paper is the positioning of commodities as an asset class that has low correlation with equity markets, as can be seen from the table below:

The above table is taken from point no. 4 of the consultation paper.

As can be seen, all the commodities mentioned here have a negative correlation with equity markets. Even among the commodities, the correlation is quite low, especially between gold and crude or between gold and copper. This provides for good diversification. This could be one of the most important uses of commodity derivatives markets for the mutual funds.

If the proposal goes through, we may soon see many mutual fund launching either pure play commodities funds or asset allocation schemes that can offer a diversified portfolio.

The second use of derivatives could well be in the form of arbitrage opportunities. Many of you must be familiar with the arbitrage mutual fund schemes, which take the advantage of arbitrage opportunities between cash equity markets and the equity derivatives markets.

These provisions may also mean a lot for the commodities derivatives markets, which do not have a large institutional presence so far. If these proposal go through, we may see a different commodities derivatives market, too.

It is important to note here is that this is just a consultation paper, seeking feedback from the investors as well as market participants, and not a regulation.