Commodity ETFs available in the US and other developed markets have emerged as an attractive investment option
Commodity as an investment option is now available to many investors, thanks to the increased limits for international funds, and the large growth in commodity ETFs (exchange traded funds) in the US and other developed markets. ETFs represent an efficient participation option in these markets, at lower cost. However, buying a commodity stock may not always provide the same benefits, for at least three reasons: first, the company may have other businesses and may not be a pure commodity play; second, the company could have hedged its commodity positions; and third, the stock may have a high correlation with equity indices, than with commodity indices. Knowing the stock is, therefore, important. Hence, while a gold or a copper mining stock may still be a commodity play, a stock like Sterlite may be a complex play of various businesses, rather than a pure commodity play.

New realty investments
Real estate investment propositions have been on the rise as investors seek alternate asset classes, given the state of the equity markets. It is important for investors to understand the sources of income when they buy such products. Many think that they buy into the growth opportunity of a real estate project. It is really tough to replicate a private-equity strategy of buying unlisted companies and realising their value on the listing of shares. One cannot buy property with the specific intent of selling it in future, with ease. Market information about such sale can depress prices. Real estate is not prone to the kind of liquidity or price efficiency that one is used to in the equity markets. Most of these investment options may actually derive their incomes from lending to real estate projects, rather than from participating in equity. Reading the fine print is important.

Realty PTCs
There is a lot of talk about real estate PTCs (pass through certificates) in mutual fund FMPs. These represent a form of securitised lending to the real estate sector. There are two ways of looking at this exposure. The conservative and much-published view is that these investments are risky, can have a high default rate, and are bought by funds with the urge to increase yield in a competitive market.
There is another way to look at this investment. The real estate sector has been a borrower in the informal markets for a very long time, at usurious rates of 36 per cent and above. It is only in recent times that cash deals and informal borrowing have come down. Many players have entered the formal markets, issuing equity and borrowing from formal channels. Informal markets feature high risks, and therefore offer higher returns. When such players choose the formal markets instead, the interest rate on their borrowing begins to fall, from the 36 per cent levels. To lenders looking at safe 12 per cent instruments, the spread is attractive enough to begin to assume some risk. Therefore, one can look at these instruments as high-yield instruments that feature a high risk that could tend lower as the shift to formal markets happen. The choice of instrument and issuer may hold opportunity rather than ignoring the entire category as junk.

Flashback
PTCs of real estate borrowers remind one of finance company borrowers when they stepped into the CP (Commercial Paper) markets in the late 1990s. In those times, finance company deposits were defaulting and were, therefore, shunned by the retail public. The credit boom represented an opportunity to finance companies to expand the market for personal loans, but lack of funds was a bottleneck. That is when many of these companies chose to issue CPs. These CPs featured higher yields and were attractive to short-term debt funds. For a long while, finance company CP in a short-term fund?s portfolio was seen as a credit risk, until the markets were able to differentiate issuer quality. We now are able to see that short-term funds actually enabled a large-scale funding of finance companies that expanded credit reach. We may see a repeat of this same phenomenon when it comes to real estate PTCs in FMP portfolios. There will be fear to begin with, some defaults will occur, but quality borrowers will continue to exist and offer yields that will be attractive to them and to debt funds.

Footnote
A note to add to last week?s piece on a long-term holding in a short-term FMP. I had highlighted the possible interest-rate risk, when the security is transferred from one FMP to another. If the instrument has a residual maturity of less than 1-year, and is held in a 90-day FMP, it is not required to be marked to market. Only if the residual maturity is over one year that the interest rate risks arise.