Risks Associated with Commodity Mutual Funds
Although there are several benefits associated with commodity mutual funds, due to their price fluctuation, the following risks can be identified while investing in commodity mutual funds:
1. Principal Risk: Commodity prices tend to be extremely volatile, and the commodities industry can be significantly affected by any world events, import controls, government regulations, and economic conditions all over the globe, all of which can have an impact on commodity prices. There is a chance that investors could lose significant value from their holdings.
2. Volatility: Mutual funds that track a single sector or commodity will possess higher volatility than the average. When a commodity fund invests in futures, options, or other derivative instruments, it can further increase the volatility of the investor’s portfolio.
3. Foreign and Emerging Market Exposure: Along with the other risks associated with commodity funds, these funds also carry the risks that go along with investing in foreign and emerging markets, as the risk can be caused by volatility caused by political, economic, and currency fluctuations.
4. Asset Concentration: Although commodity funds can play a role in the diversification strategy of any portfolio, they are considered non-diversified as they have to invest a significant portion of their assets in fewer individual securities that are generally concentrated in 1 or 2 industries focusing on commodities. So even a small change in the market value will cause greater fluctuations in the share price than would have occurred in a more diversified fund.
5. Other risks: Funds that focus on commodities use futures contracts to track an underlying commodity or commodity index, due to which trading in these types of securities is speculative and can be extremely volatile. This causes a significant decline in the performance of a fund. Due to price fluctuation, the result can be either negative or positive, depending on the market performance.
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