When it comes to creating a portfolio, following optimal asset allocation is of paramount importance. This is because by allocating investments across various asset classes, you can shield the portfolio from any adverse development in one particular asset class, thereby aiding in generating an optimal risk-adjusted return. Also, each asset class has a unique role to play in a portfolio. While equity provides the growth element through capital appreciation, debt renders the much-needed stability and commodities such as gold and silver provide a hedge against inflation.

Relevance of Commodities
The allocation to commodities often tends to be minimal as investors tend to undermine its importance in a portfolio. It is only in times of uncertainty when other asset classes like equity become very volatile that investors realise the benefit of having a recognisable allocation to commodities. A recent example of this was during the outbreak of the pandemic and during the Russia-Ukraine conflict.

Making commodities a part of your portfolio offers three distinct benefits:

1) Portfolio diversification – Let us consider a scenario where you see the market steadily heading north and decide to allocate a majority of your corpus to equity investments. However, keeping in mind your asset allocation requirements, you refrain from going overboard. A few days later, owing to a negative development, equity market sentiments take a beating. As a result, the funds allocated to equities witness a sizeable correction. At the same time, gold, a safe haven commodity, logs strong gains. This, in effect, helps offset the losses in equities by a sizeable extent. This is what portfolio diversification ensures, especially when you diversify into commodities.


2) Hedge against inflation – Investing in commodities helps you withstand inflation. During high inflation scenarios, the demand for commodities also goes up, ensuring that your investment benefits from the rise in prices. In addition to inflation, commodities also act as a good hedge against the dollar. Usually, when the US dollar falls, commodity prices tend to rise, creating a win-win situation if you are building positions in both these assets.

3) Improving potential portfolio returns – Commodity investments can help you optimise returns because of the underlying global demand. While commodity prices are susceptible to fluctuations owing to changes in interest rates and global volatility, a strong demand ensures an overall positive impact on commodity returns.

Now that you know why commodities make a good fit for your portfolio, what is the best way to make this happen? The easiest way to achieve exposure to commodities is through the ETF route.

Choosing ETFs
Many of us wish to invest in gold and silver but do not want to face the hassle of buying actual commodities as safe storage is a matter of concern. In such a situation, gold and silver ETFs emerge as a viable option to invest into commodities. This is because through the ETF route, one need not worry about storage and theft as ETFs are held in the demat form. Besides, the cost of acquisition is low given the absence of making charges and other related expenses. There is also absolute flexibility when it comes to buying and selling. As ETFs are listed on the exchanges, an investor can carry out a transaction at any point during trading hours. There is no lock-in period. Lastly, investors can start accumulating gold or silver even with smaller sums of money.

An investor without a demat account can consider investing in gold or silver fund of funds. If an investor is planning to meet any future requirement of gold — say, a wedding — then such an investor can consider doing a SIP for as low as Rs 1,000 every month in gold fund of funds. This will enable the investor to collect gold units over a period of time. Similar is the case with silver.

In effect, ETFs make it easy to participate in the commodity market and hold positions for long, thus making them an excellent choice for portfolio diversification. Historically, Indians have had a strong affinity for precious metals. Now, you can use these commodities-based ETFs to add lustre and glitter to your portfolio while ensuring optimal diversification.

(The author, Nitin Kabadi, is Head – ETF Business, ICICI Prudential AMC. Views are his own)