Commodity Mutual Funds for Diversification
Commodity mutual funds are those mutual funds that invest in certain real property assets or their derivatives like futures contracts (instruments that facilitate investment in commodities). The commodity mutual funds then trade on the commodities or the 
derivatives for maximizing profits. Commodity mutual funds provide an interesting alternative to diversify your investment portfolio beyond stocks and bonds, as there are times when financial assets are out of favor.
Commodity mutual funds can be thought of as scaled-down versions of institutional hedge funds (hedge funds are for investors who can pool large sums of money for the purpose of trading in commodities). In a way, commodity mutual funds are smaller versions of hedge funds that provide a chance to retail investors to try their hand in the commodities market when they do not have sufficient capital to invest in hedge funds.
Benchmark Indices for Commodity Mutual Funds
Unlike virtual assets in the conventional markets (such as option derivatives), the commodities market facilitates trades in real assets. For example, we have two popular indices marking the commodities market. One is the Goldman Sachs Commodity Index (GSCI) and the other is the Dow Jones Commodity Index (DJCI). Most commodity index mutual funds are benchmarked against either of these indices.
GSCI has 22 different commodities in the index . About 55% of this index is made up by energy futures and another 25% by agriculture commodities. The remaining 20% is spread amongst bond markets. Such a broad based and diversified index gives weight to long-term and un-leveraged commodities. The weight is calculated on the basis of the commodities currency flow through in the economy. The quantity and their presence in the index are calculated based on the average production for five years.
DJCI is a pretty liquid index with broader outlook and based on the worldwide importance of commodities. No commodity can have a representation of more than 33% in the DJCI.
Most of the best commodity mutual funds are benchmarked against either of the indices for comparison.
What Contracts do Commodity Mutual Funds Invest In?
By investing in “future contracts” (an industry jargon for instruments of contract for commodities & prices), commodity mutual funds speculate on futures prices. The contracts are made for a future date and price, and have a binding obligation both on the buyers and sellers. These futures (contracts) are listed and traded on exchanges, and their values vary based on speculation and hedging (risk reduction). While some future notes are delivery based (delivered to the buyer), some others are cash settled upon expiry of the contract at the higher of the speculated value and the contract value.
To ensure a semblance of stability, the commodity mutual funds will invest the balance money with them in short-term government securities. Apart from paying for the operating expenses, the returns on these will complement returns from commodities investments. A small amount may be set aside for speculative trading in commodities like silver and oil. Some commodity mutual funds also counter the effects of inflation by the earnings they make on government securities – these are known as inflation insulated or inflation free commodity mutual funds.
Where to Invest in Commodity Mutual Funds
Many financial institutions allow investors an opportunity to invest in commodity mutual funds or commodity index mutual funds. Look for companies that have a large capitalization and have been in the business for years, such as TRowePrice.com, Fidelity.com and Vanguard.com.
Commodity Mutual Funds List
Here is a list of the top commodity mutual funds according to Money-Zine.com:
- Oppenheimer Real Asset Fund
- PIMCO Commodity Real Return Strategy
- Goldman Sachs Commodities Index
- Deutsche Bank Liquid Commodities Index
- Rogers International Commodities Index
- Dow Jones AIG Commodities Index