Definition and Examples of Commodity Funds
A commodity fund invests in commodity assets, which are generally natural resources like oil and gas, or agricultural products like wheat and corn. These investment vehicles can take several forms, such as exchange-traded funds or mutual funds. Within commodity investing, there’s a level of standardization for buyers and sellers, where the goods being traded are generally deemed interchangeable.
One example of a commodity fund is Parametric Commodity Strategy Institutional Fund (EIPCX), which includes more than 30 different commodity types, including agricultural, energy, livestock, and precious metals. Another good example of a commodity fund is the BlackRock Commodity Strategies Fund (BICSX), which is a fund comprised of various commodity-related companies and commodity-link derivatives.
How a Commodity Fund Works
Commodity funds typically work by investing commodities through one or a combination of ways, such as:
- Direct commodity investing: Some commodity funds own the underlying commodities, such as gold or silver. This direct investment can trigger higher capital gains taxes than other types of investments.
- Investment in commodity-related equities: Some commodity funds are actually regular stock funds that provide exposure to commodities by investing in companies that are involved in commodities. For example, a commodity fund might invest in mining company stock.
- Commodity futures: Another common way that commodity funds work is by investing in commodity futures contracts. With futures, buyers and sellers agree to trade at a set price at a later date. That set price can help farmers, for example, by locking them into a sale price for crops, rather than being subject to supply and demand price swings later on. For investors, however, returns on commodity futures depend on whether commodity prices rise or fall. Commodity futures may also involve complex tax treatments that differ from traditional capital gains.
Commodity funds can differ in terms of their diversification, too. Some commodity funds might specifically invest in one type of commodity, like gold or silver, whereas others might provide exposure to a broader category, like precious metals. Others provide exposure to a mix of commodity categories—rather than making you invest in precious metals or agriculture separately, you can invest in all of them through a single fund.
What Commodity Funds Mean for Individuals
Commodity funds can provide ways for individuals to get exposure to different types of assets than they might normally access through traditional stock or bond funds. Doing so can provide benefits like diversification, as commodities generally have a low correlation to the stock and bond markets. However, if you’re investing in commodity funds that invest in the equities of commodity-related companies, that might affect that level of correlation.
Commodity investing can also provide protection against inflation, as inflation generally means that commodity prices are rising, so investors can benefit from those increases.
Commodity Fund Risk
However, commodity funds also carry risks. They can be subject to volatility that can be hard to predict. Global political events can cause oil prices to quickly rise or fall, or weather events could affect the price of agricultural crops. Also, commodity funds can involve some complex tax situations.
Because of the high-risk, high-reward nature of commodities, if you’re interested in commodity funds, you may want to consult with a professional advisor who can offer advice based on your risk tolerance and investment goals.
- Commodity funds provide investors with exposure to commodity markets, like energy materials and agricultural crops.
- Commodity funds can be structured in several different ways, such as with some funds directly owning commodities and others investing in futures contracts.
- Taxes on commodity funds can be complex and might differ from some other types of investments.
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