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Commodity funds are mutual fund schemes that give investors exposure to commodity prices without requiring them to buy and store the physical commodity themselves. In India, this exposure is most commonly seen through Gold Exchange Traded Funds, Silver Exchange Traded Funds, and commodity-based Fund of Funds.
In this article, you will learn what commodity funds mean, the different types available, how they invest, how Gold and Silver funds work, and more.
Key Takeaways
- Commodity funds offer indirect exposure to commodities via Exchange Traded Funds (ETFs), Fund of Funds (FoFs), and derivatives.
- Gold and Silver ETFs are the most prominent retail commodity products in India and trade on recognised stock exchanges.
- Commodity-based FoFs invest in underlying commodity ETFs, eliminating the need for a demat account.
- SEBI permits eligible mutual fund schemes to participate in Exchange Traded Commodity Derivatives (ETCDs) under strict risk controls.
- Commodity investments carry price volatility and tracking error risks, and are taxed based on asset holding periods.
What are Commodity Funds?
Commodities are basic physical goods, raw materials, or primary agricultural products that are traded on regulated exchanges (such as the Multi Commodity Exchange or National Commodity and Derivatives Exchange in India). They are interchangeable with other goods of the same type, meaning a metric ton of wheat or a bar of gold holds the same market value regardless of who produced it.
Investors and industries seek exposure to four primary commodity sectors:
- Energy: Crude oil, natural gas, heating oil, and coal.
- Precious Metals: Gold, silver, platinum, and palladium.
- Industrial Metals: Copper, aluminum, zinc, and nickel.
- Agriculture & Softs: Wheat, corn, soybeans, coffee, sugar, and cotton.
Types of Commodity Funds
Commodity-oriented investment vehicles in India span several distinct categories:
- Gold ETFs: Mutual fund schemes designed to track the domestic price of gold. Units trade on stock exchanges and require a demat and trading account.
- Silver ETFs: Schemes providing exposure to silver following SEBI’s regulatory framework introduced in 2021. Silver carries both investment and industrial demand drivers.
- Commodity-based Fund of Funds (FoFs): Schemes that invest in units of underlying commodity ETFs rather than holding physical bullion or derivatives directly, allowing investments via regular mutual fund folios without a demat account.
- Schemes Using Exchange Traded Commodity Derivatives (ETCDs): Permitted mutual fund schemes that participate in standardised commodity derivative contracts on recognised exchanges, subject to SEBI limits on net short positions and physical settlement rules.
- Multi-Asset Allocation Funds: Hybrid schemes combining equity, debt, and commodity instruments (such as gold or silver) within a single portfolio to achieve asset class diversification.
Choosing Between ETFs, FoFs, and Multi-Asset Funds
Selecting the right vehicle depends on an investor’s infrastructure (Demat access), investment style, tax efficiency needs, and overall portfolio goals.
1. Exchange Traded Funds (Gold & Silver ETFs)
Best suited for active, cost-conscious investors seeking direct and precise exposure to bullion prices.
When to Prefer:
- Low Expense Ratios: You want the lowest possible management fee (TER) for pure commodity exposure.
- Tactical / Real-Time Trading: You want the flexibility to buy or sell units at live intraday market prices on NSE/BSE rather than waiting for end-of-day NAV.
- Existing Demat Setup: You already maintain an active Demat and trading account for equity investments.
Key Considerations:
- Requires managing brokerage fees and monitoring liquidity/bid-ask spreads on the exchange.
- Capital gains are taxed at applicable slab rates (for holding periods up to 12 months for direct specified mutual funds/ETFs) or long-term tax rates depending on current regulatory guidelines.
2. Commodity-Based Fund of Funds (FoFs)
Suited for passive or SIP investors who prefer simplicity and do not operate a Demat account.
When to Prefer:
- No Demat/Trading Account: You want to invest in gold or silver via standard mutual fund folios through regular distributors or direct mutual fund platforms.
- Automated Disciplined Investing: You want to set up recurring Systematic Investment Plans (SIPs) or Systematic Transfer Plans (STPs) directly from your bank account without manual exchange transactions.
- Fractional & Small Ticket Allocation: Ideal for investing fixed, smaller amounts (e.g., ₹500–₹1,000/month) where buying whole ETF units on an exchange might be inconvenient.
Key Considerations:
- Carries a dual expense structure (underlying ETF expenses + FoF management fees), making total costs slightly higher than direct ETFs.
- Transactions execute at end-of-day NAV rather than real-time market prices.
3. Multi-Asset Allocation Funds
Suited for hands-off, long-term investors looking for automated asset allocation and rebalancing within a single fund.
When to Prefer:
- All-in-One Diversification: You want a single portfolio that dynamically blends Equities (growth), Fixed Income (stability), and Commodities (inflation hedge/safe haven).
- Automated Rebalancing: You prefer a professional fund manager to rebalance weights across equity, debt, and commodities during market cycles, eliminating the need to manually buy/sell individual assets.
- Tax Efficiency on Rebalancing: Portfolio rebalancing inside a multi-asset fund does not trigger capital gains tax for the unit holder unlike manually selling equities to buy gold ETFs in a personal portfolio.
Key Considerations:
- Commodity exposure is partial (10%–25% depending on fund strategy), so it is not suitable if your explicit objective is a pure, concentrated allocation to gold or silver.
|
Parameter |
Commodity ETFs |
Commodity FoFs |
Multi-Asset Allocation Funds |
|
Primary Goal |
Pure direct exposure to gold/silver |
Pure exposure via disciplined SIPs |
Holistic multi-asset portfolio diversification |
|
Demat Account Required? |
Yes |
No |
No |
|
Execution |
Live exchange trading |
End-of-day NAV |
End-of-day NAV |
|
SIP Convenience |
Moderate (Broker SIPs) |
High (Native Mutual Fund SIP) |
High (Native Mutual Fund SIP) |
|
Rebalancing Overhead |
Manual (DIY) |
Manual (DIY) |
Automatic (Handled by Fund Manager) |
|
Relative Expense Ratio |
Lowest |
Slightly Higher (Underlying + FoF) |
Standard Mutual Fund TER |
How do Commodity Funds Work?
Step 1: Capital Pooling (Money In)
Investors buy units of the commodity fund (such as Gold or Silver ETFs or Fund-of-Funds) through stockbrokers or directly from the Asset Management Company (AMC). This money is pooled into a single fund corpus.
Step 2: Asset Acquisition & Custody
The fund manager uses pooled cash to purchase physical commodity bullion (e.g., standard purity gold or silver bars). Under SEBI regulations, this physical asset is stored securely in vaults managed by an independent custodian.
Step 3: Daily Valuation & NAV Calculation
Each day, the fund calculates its Net Asset Value (NAV). The physical holdings are valued using polled spot market prices from recognised stock exchanges. The fund deducts applicable operating expenses, such as management fees, custodian fees, and transaction charges, from the total value.
Step 4: Price-Linked Returns
The investment returns are directly tied to the price movement of the physical commodity. When spot gold or silver prices increase or decrease in the market, the fund's NAV moves proportionally (minus minor tracking differences caused by fees and small cash holdings).
Step 5: Liquidation & Redemption (Money Out)
When an investor decides to exit, they sell their fund units on the stock exchange or redeem them directly with the AMC at the current prevailing NAV, receiving the cash directly in their bank account.
Taxation of Commodity Funds in India
Under the updated tax framework (post-Finance Act 2024 and Section 50AA revisions), commodity instruments, such as Gold/Silver ETFs and Gold/Silver Funds of Funds (FoFs), are treated as non-equity specified assets. Indexation benefits are no longer available for any new redemptions, but long-term capital gains (LTCG) qualify for a reduced 12.5% flat tax rate.
Numerical Thresholds & Holding Periods
|
Instrument Type |
Minimum Holding Period for LTCG |
Short-Term Capital Gains (STCG) Rate |
Long-Term Capital Gains (LTCG) Rate |
|
Gold / Silver ETFs (Listed on Indian stock exchanges) |
> 12 Months |
Income Tax Slab Rate (Up to 30% + surcharge/cess) |
12.5% (Without Indexation) |
|
Gold / Silver FoFs (Unlisted mutual fund units) |
> 24 Months |
Income Tax Slab Rate (Up to 30% + surcharge/cess) |
12.5% (Without Indexation) |
Benefits of Commodity Funds
-
No Physical Storage: Eliminates theft risk, vaulting fees, and purity-verification concerns associated with physical bullion.
-
Portfolio Diversification: Commodities exhibit a low correlation with traditional equity and debt asset classes, helping cushion overall portfolio volatility.
-
High Liquidity: ETFs can be traded intraday on stock exchanges, while FoFs can be redeemed directly with the fund house at prevailing NAVs.
-
Transparent Pricing: Daily NAV disclosures ensure investors track market valuations accurately.
Risks of Commodity Funds
-
Commodity Price Volatility: Sharp macroeconomic shifts, global supply chain adjustments, and currency fluctuations can depress underlying asset values.
-
Tracking Error: Expenses and operational frictions can cause fund returns to lag behind actual commodity price movements.
-
Concentration Risk: Single-commodity funds lack sector diversification, exposing portfolios entirely to the cyclical swings of that specific asset.
Commodity Funds vs Physical Commodities
|
Feature |
Commodity Fund |
Physical Commodity |
|
Ownership Form |
Electronic units (Demat or folio) |
Physical metal or goods |
|
Storage & Security |
Managed by institutional custodians |
Requires bank lockers or home safes |
|
Purity Risk |
None (backed by standardised bullion) |
Verification required at resale |
|
Transaction Costs |
Expense ratios, brokerage, exit loads |
Making charges, GST, dealer margins |
|
Liquidity |
High (exchange-traded or direct redemption) |
Dependent on local bullion dealer buyback |
|
Investment Objective & Return Generation |
Designed for capital appreciation tracking the underlying commodity spot prices; generates returns solely through price movement without any interim cash flow. |
Held for wealth preservation, hedging against inflation/currency depreciation, and asset diversification; generates returns purely through capital gains upon liquidation. |
Conclusion
Commodity funds provide a way to participate in commodity markets through regulated investment structures. In India, gold ETFs, silver ETFs, commodity-based fund of funds and schemes permitted to use Exchange Traded Commodity Derivatives are some of the ways mutual fund investors can obtain commodity exposure. SEBI's current framework specifically sets out how mutual fund schemes can participate in commodity derivatives and how physical Gold and Silver may be held and valued.
