September 15 2010 by
Pawan M Kumar in
commodity |
Advantages of managed funds
Owning the units of the fund house gives lot of advantages to the holder in commodity trading like instant exposure to commodities in the market the fund is targeting, diversification, better asset allocation, professional management, the ability to make an initial investment with a minimal amount, and greater access to opportunities in the commodities markets.
Greater Exposure
You immediately become the owner of all the companies that your fund owns. For this reason, you gain instant exposure to a broad spectrum of companies, from energy to precious metals and from industrial metals to transportation companies. Furthermore, when you make subsequent investments in the mutual fund, you increase your ownership of each company and gain an even bigger foothold in the commodities markets in which each company operates.
DIVERSIFICATION
One of the Main benefits of investing in mutual funds is that you get to diversify as you own a part in a hand full of companies. When you invest in individual companies, you are exposed to two types of risk: company-specific risk and non-company- specific risk. Company-specific risk arises from specific actions of management that are unique to a firm, it. Unfortunately, investors are typically unable to minimize non-company-specific risk through diversification since investing in multiple companies does nothing to control the ways in which the market can affect a portfolio. There are strategies that many hedge funds employ to control market risk, such as selling short a market index fund. Nonetheless, diversification is very important with commodities investing, and mutual funds offer this benefit.
BETTER ASSET ALLOCATION
Not to be confused with diversification, which deals only with companies in a single sector such as energy, asset allocation is about dividing your investment among the different commodities markets. Thus, if you invest in a mutual fund that holds only energy companies, your investment will be diversified but not properly allocated since you will have omitted other commodities markets, such as precious metals and industrial metals. The more commodities markets you invest in, the better your asset allocation and the more ideal your risk and return profile.
Skilled and Experienced Management
When you invest in commodities, you can use the do-it-yourself approach, in which you do all the research and make all the decisions, or employ professionals who have expertise in this area. Investing in commodities companies is not the same as investing in blue-chip companies. You must be more skilled and spend more time researching companies, markets, and trends when you invest in commodities companies. This self-directed approach will save you money since you will not have to pay someone else to do it for you, but it is not for everyone. For the typical investor who simply wants to gain extra exposure to commodities, using a professional manager or index investment is the preferred approach.
INVESTOR-FRIENDLINESS
Most commodity mutual funds have very minimal entry investment, which is manageable however investing in commodities is not for everyone.
Researched and Good Opportunities
When you pool your money with other investors, you gain access to some investments that you would not be able to purchase if you invested by yourself. Some of these opportunities include initial public offerings (IPOs) and structured debt. Although this benefit is more important with non-commodity mutual funds, there are some circumstances in which it can be a nice bonus. This benefit t is something to keep in mind when you are trying to decide between mutual fund investing and do-it-yourself investing.
Drawbacks of Mutual Funds
Management Fees
The biggest knock against mutual funds is the high fees they charge investors for professionally managing their money. Many commodities mutual funds assess an annual fee in excess of 1.00 percent or 1.50 percent. Thus, if you earn 10 percent in a mutual fund that charges a 1.40 percent fee, you pay 14 percent of your gain for investing in that fund. Let’s take this example further. If you earned 2.80 percent in your fund, you are given a bill for 50 percent of the earnings you have made. Note that if your fund losses money, you still have to pay the fee. Taking a loss in your account and paying someone on top of that for poor performance is an obvious problem inherent in mutual funds. Many investors and financial advisors do not invest in mutual funds because of the high fees and instead employ index based mutual funds or exchange-traded instruments such as exchange-traded funds (ETF’S) and exchange-traded notes (ETN’S).
Benchmarking
If you had two choices of investments, option A, which generated a return of 10 percent and assessed an annual fee of 1.25 percent, and option B, which generated a return of 11 percent and assessed an annual fee of 0.50 percent, which one would you select? The obvious answer is option B. With this example, option A is a typical mutual fund and option B is an equivalent index fund. Much research has been done on money managers and how well they perform against an appropriate benchmark. Most research has concluded that the majority-approximately 80 percent-of money managers do not outperform their benchmarks. Furthermore, money managers who do outperform their benchmarks in any specific year have a lower probability of outperforming that benchmark the next year. Over any holding period there will be some money managers who outperform their benchmarks, but most will not. The number of money managers who outperform the market will be no greater than predicted by standard mathematical probability. It is simply the law of large numbers accompanied by statistical outliers. So what does this mean to you as a potential commodities investor? It means that you need to do your homework about each mutual fund before you start trading in commodities through mutual funds. Secondarily, it means that you should consider whether investing in a mutual fund is the smart choice or whether you should invest by using an index-based mutual fund or exchange traded fund or note.
Author: Pawan M Kumar
Article Source: EzineArticles.com
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