In essence, commodity funds invest in various agricultural products such as oil, gold, corn, or livestock. Some commodity funds invest in futures, options, or stocks of companies. While commodity funds are not as popular as bonds or stocks, this can provide an opportunity for any investor.

Commodity fund encompasses different types of investments, including:

Commodity Funds. These funds directly hold commodity. For instance, gold funds investing in the stocks of gold mining firms.

Commodity Funds Holding Futures. In the commodities markets, commodity-linked instrument is a much more common mutual fund. Majority of investors have no intention of delivering hogs, corn, or other commodity, but to cash in on price changes. One way to achieve that goal is to purchase futures contracts.

Combination Funds. Certain funds combine actual commodities and commodity futures. For example, gold funds include both bullion and futures contracts.

Natural Resource Funds. This derivative focuses on companies involved in businesses which operate in commodity-related fields, including agricultural business, energy, mining, and oil drilling. Although it do not hold actual commodities or commodity futures, it can offer exposure to the commodities markets.

In general, commodity funds provide numerous investment techniques, such as active management and passive management. Active portfolios seek to surpass a benchmark index by purchasing and selling. Conversely, passive portfolios seek to mirror a benchmark index and match its performance through exchange-traded funds or index funds.

Investing in these funds greatly helps in portfolio diversification and minimizing losses since they have a portfolio element not commonly found in bonds, mutual funds, or stocks. Commodities also have low correlation to conventional equity markets, meaning they do not always fluctuate alongside market movements. Aside from hedging against inflation, commodities provide upside potential. The law of supply and demand is applicable to almost every raw material used in several industries. So, if demand climbs, prices normally follow, leading to profit for traders.

But just like any other markets, commodities markets are volatile in nature, and also have short-term price swing and long lulls. Another is the mutual funds and benchmark indexes being trailed. Energy is often the heavyweight in many commodities indexes. When attempting to replicate the index, expect that more than half of the fund’s assets will be placed in energy. But some funds limit the percentage of the portfolio invested in a commodity to avoid over-concentration.

Can investors really depend on commodity funds? Yes, it can provide portfolio diversification, but proceed with caution. Before taking the leap, read the fund’s annual report and prospectus. Make sure you fully understand the fund and what it can do for your portfolio. Commodity markets are volatile, so pay attention to its holdings.