Commodity market sees big liquidity push with mutual fund foray

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Mutual funds and portfolio management services (PMS) providers’ entry into the commodities derivatives segment will give a big boost to the derivatives market, especially in terms of liquidity. 

It will help raise hedging, especially by producers, and improve depth and liquidity in far-month co­n­tracts. Initially, mutual fund ho­u­ses and will go slow to understand the market first but are optimistic about the opportunities bei­ng thrown open by the regulator.

The board of the Securities and Exchange Board of India (Sebi) has approved a proposal to allow MFs, regulations for which are being prepared. 

But the department of financial services under the Union ministry of finance is understood to have expressed its concerns, saying this will raise speculation levels in commodity derivatives.Several PMS firms, brokerages running PMS and at least five of the top 10 mutual funds along and a few mid-sized funds are looking at the schemes with commodity assets, said an industry observer.

Mrugank Paranjape, managing director (MD) & chief executive officer (CEO) of MCX, the largest commodity derivatives exchange, said, “Institutional investors will help the commodity markets in two very specific ways: first, they will help retail investors get an informed option for investing in this market and second, their own need for long-term investment will help build liquidity in the far-month contracts.”

MFs are for long-term investors. They are also not allowed to speculate and short sell. Hedge funds or alternative investment funds are already allowed to participate in commodity derivatives and can speculate within the norms. Although hedge funds are not yet active, only stable institutional investors can counter them. “MFs are required for orderly growth of commodity derivatives,” said a commodity advisor who is also associated with the regulator.

MFs, as long-term investors, would like to buy in long-duration contracts and they are illiquid.

A CEO of one of the top asset management companies, said, “We are awaiting regulations which will clarify commodities in which we can enter and whether we have to launch independent schemes for commodities or hybrid schemes.”

Chandresh Kumar Nigam, MD & CEO, Axis AMC Ltd, said, “We are excited about the opening up of commodity investments to mutual funds. We believe there is a great long-term opportunity in this sector. We expect the start to be slow, given the commodity performance in the last few years as well as operational complexities for fund houses, especially linked to delivery/custody of physical commodities. We believe that asset allocation products are likely to be the immediate vehicles for fund houses to offer commodity exposure to retail investors. However, we will be able to take the final call on product strategy once the Sebi guidelines come out.”

Some fund houses have been exploring the possibility of commodity derivatives trading since the last two years and a few brokerages had started advising their clients to take positions which are synchronised between commodity derivatives and equities. One of them said its investors made much higher gains with the blending.

One senior official of the equity exchange said, “We are discussing this issue with fund houses but more concrete discussions will be possible after details of documentations and focus of the schemes are clarified.” After that, based on MFs’ response, “We will also consider launching special schemes for them,” the official added.  

Nilesh Shah, MD & CEO, Kotak AMC Ltd, said there are some challenges also. “One is to understand the market. Second, is to have a settlement guarantee so that NSEL isn’t repeated,” he said.
What lies ahead
  • MFs need to understand commodity as an asset class
  • Counterparty long-term sellers also needed
  • Producers can sell future produce, if they have institutional investors as buyers
  • Current shallow liquidity is a limiting factor for them
  • Security market players like custodians need to learn to deal with physical commodities 
  • Agri commodities may still not attract MFs

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