SEBI allows participation of MFs in commodity derivatives market

The market regulator Securities and Exchange Board of India(SEBI) vide a circular dated May 21, 2019 has allowed mutual funds to participate in the commodity derivative market in India. Mutual funds can now invest in commodity derivatives through ETCDs (Exchange Traded Commodity Derivatives).

As per SEBI, no mutual fund shall invest in physical goods except in gold through gold ETFs (Exchange Traded Funds). As mutual funds participating in ETCDs may hold the underlying goods in case of physical settlement of contracts, in that case, mutual funds shall dispose of such goods from the books of the scheme, at the earliest, not exceeding 30 days from the date of holding of the physical goods. Further, no mutual fund can have net short positions in ETCDs on any particular good, considering its positions in physical goods as well as ETCDs, at any point of time. When it comes to participation of mutual funds in commodity derivatives via ETCDs mutual funds are permitted to participate in ETCDs through hybrid mutual fund schemes including multi-asset allocation funds and gold ETFs.

However, prior to participation in ETCDs, the AMCs (Asset Management Companies) shall appoint a dedicated fund manager with requisite skills and experience in the commodities market, including commodity derivatives market. AMCs also need to appoint a custodian who is registered with the Board for custody of the underlying goods, arising due to the physical settlement of contracts. They also must have a written investment policy statement for participation in ETCDs and also get the approval from the Board of the AMC and the Board of Trustees. Even they must have written down valuation policies that is approved by the Board of the AMC and the Board of Trustees for valuation of commodity derivatives and the underlying goods, arising due to physical settlement of contracts and the approved valuation policies should be subject to the principles of fair valuation of the assets of mutual funds schemes. Mutual funds investing in ETCDs shall be benchmarked against an appropriate benchmark. Until FPIs are permitted to participate in ETCDs, AMCs can’t onboard FPIs (Foreign Portfolio Investors) in mutual funds investing in ETCDs.

SEBI has also put forth certain investment limits. According to SEBI, Mutual funds shall participate in ETCDs of a particular good (single), not exceeding 10 per cent of NAV (Net Asset Value) of the scheme. However, the limit of 10 per cent is not applicable for investments through Gold ETFs in ETCDs having gold as underlying. In the case of multi-asset allocation funds, the exposure to ETCDs shall not be more than 30 per cent of the NAV of the scheme. In case of other hybrid schemes excluding multi-asset allocation funds, the participation in ETCDs shall not exceed 10 per cent of NAV of the scheme.

So, is it beneficial? It can be beneficial as now mutual funds can further diversify their portfolio and try to lower the risk. Commodity being highly cyclical and volatile can also prove to be risky. However, SEBI has taken care of this aspect by putting limitations on investments. Also, it has asked the AMCs to have a dedicated fund manager having experience in commodity and exchange-traded commodity markets. Only time will tell how this works for mutual funds.