The Commodity Conundrum


nsel_logoAbout 2 months back someone asked me to invest in a new commodity product that was guaranteed to return 12-16% a year, I cut them off before they gave me more details and said “no thank you”. I told them I would not touch commodities with a 10 foot pole after being burned by the commodity markets in 2006…December 7, 2006 to be exact. I remember that day vividly because I woke up feeling like a million bucks because it was the day I was getting my marriage registered at the Bombay Courts. I grabbed the newspaper and immediately felt like someone punched me in the gut. The FMC (Forward Markets Commission) had announced they were banning hedge funds in the commodity markets.

The FMC is the regulatory authority for commodities like SEBI (Securities and Exchange Board of India) is for equities. I use the term “regulatory” very loosely, to say the commodity markets are politically controlled would be an understatement. In India the largest industry in terms of revenue and people employed is agriculture, which brings a whole host of political people trying to “help” the farmer.

In mid 2006, the Minister of Agriculture was getting intense heat from the rest of the government for the rise in essential commodity prices which saw onion prices go through the roof. The Minister of Agriculture is none other then political heavy-weight Sharad Pawar. The Minister of Agriculture decided to act via the FMC and ban all hedge funds from trading on the National Commodity and Derivatives Exchange (NCDEX) and Multi Commodity Exchange (MCX). The FMC was more concerned about NCDEX since that is where many of the Indian agro commodities trade. Our fund and about 10 others were out of business overnight – December 7, 2006. We had dealt with the FMC for many months prior and it was clear they were not calling the shots, they were being told what to do. In the crossfire the hedge funds were collateral damage.

Enough about my sob story, back to this new commodity product being pushed by many of the big brokerage houses. The product was traded on the National Spot Exchange Limited (NSEL) which was backed by Jignesh Shah of Financial Technologies. At MProfit we were increasingly getting requests to create an import template for these contracts so people could track their investments in our software. When people showed us the contract notes where the buy and sell prices had already been established, that should have been a red flag. However, like everyone else we figured it was legitimate because it had the stellar reputation of the Financial Technology group behind it. Not to mention the equity markets were dead so people must have moved to this new exchange to trade the markets…wrong.

When the NSEL issue came to light I had a chat with the head of a large commodity broker who had some exposure to the product, rather his clients has exposure to the product. He was very adamant that it was the government’s fault (not true) and that clients would get their full money back (pretty sure that ain’t happening). The minute I heard that the NSEL might not have the money to cover all the investors I knew right away the goods were probably never there, either fictitious warehouse receipts or sub-standard commodities were being warehoused.

I’ve heard from several people that some of the brokers were unofficially pushing it as a commodity PMS (Portfolio Management Service) which is ILLEGAL in India. Equity PMS products are legal since they come under the purview of SEBI, whereas the FMC banned PMS products in commodities on December 7, 2006 (yes, that date is etched in my forehead!). And just recently, someone forwarded me a product presentation slide deck for a commodity PMS being offered by Forefront (click for preso). It mentions the fund is registered under SEBI’s Alternative Investment Funds (AIF) rules, but commodities fall under the FMC lens. So who has jurisdiction over this fund if things get out of control? Everything looks great on paper until the shit hits the fan.

This type of jurisdictional conundrum is what caused the NSEL to spiral out of control. No one had regulation over the spot markets which is what the NSEL was all about – hence their name National Spot Exchange Limited.


The Motilal M50 ETF is a Bad Remix


motilal_M50-1Three years ago Motilal Oswal launched it’s asset management company (AMC) and decided to focus on exchange traded funds (ETFs) as opposed to mutual funds. An AMC is just a fancy description for a financial institution that is selling mutual funds. ETFs are similar to mutual funds but instead of buying them from a mutual fund company you buy them on an exchange such as the National Stock Exchange (NSE) hence the name exchange traded funds.

The first product out of the Motilal Oswal AMC stable was the Nifty M50 (my blog post from 3 years ago). It launched in July 2010 and was touted as taking the 50 stocks that make up the Nifty index and then “remixed according to Motilal’s predefined methodology based on fundamental performance and valuations” – their words not mine. In the marketing material for the M50 it showed how the M50 kicked the Nifty index to the curb in terms of performance.

So here we are three years later and how has the M50 done as compared to it’s main competitor the Goldman Sachs Nifty BeES? Since the M50 marketing material compared itself to the Nifty Index I add that to comparison as well.

After year 1 (July 30, 2010 to July 29, 2011)
Motilal M50 -5.90% (yes, negative 5.90%)
GS Nifty BeES +3.72%
Nifty Index +2.13%
The delta between the M50 and BeES was 9.62% (962 bps)

After year 2 (July 30, 2010 to July 30, 2012)
Motilal M50 -12.09%
GS Nifty BeES -3.51%
Nifty Index -3.13%
The delta between the M50 and BeES was 8.58% (858 bps)

After year 3 (July 30, 2010 to July 30, 2013)
Motilal M50 -5.40%
GS Nifty BeES +7.09%
Nifty Index +7.22%
The delta between the M50 and BeES was 12.49% (1249 bps)

The numbers speak for themselves, from the very beginning the M50 has underperformed as compared to the GS Nifty BeES and the Nifty Index. When it was launched it was marketed as India’s first actively managed ETF, which just means it’s a regular mutual fund that is traded on the exchanges. In the end it comes down to the fund manager and the stock selection methodology, which based on the M50 numbers has done horrible and definitely something I would not recommend investing in.

Brokers and wealth advisors hate me because my personal preference is toward index trackers such as the Nifty BeES which passively replicates the Nifty index at a lower cost. The expense ratio for the M50 is 1.25% (125 bps) whereas the Nifty BeES is 50 bps. As a comparison some Vanguard ETFs in the US have expense ratios as low as 5 bps, such as the Vanguard Total Stock Market Index Fund.

However, the news is not all gloomy for Motilal’s AMC, they do have one of the best performing ETFs on the market today – the Motilal Oswal MoST Nasdaq 100. Which as the name indicates tracks the Nasdaq index, it’s probably the best low cost instrument in India to get exposure to the US markets.

Epilogue – As I was gathering content for this blog post, I saw several articles (here and here) indicating that the fund manager Rajnish Rastogi for many of the Motilal ETFs including the Nifty M50 had recently passed away. RIP.