Last week, ICICI Prudential filed an interesting new fund for approval by the Securities and Exchange Board of India (SEBI). It is the first fund in India which is linked to international crude oil prices. While such funds are not uncommon elsewhere in the world, it would definitely be a novelty in India. The premise of investing in such a fund is simple. If oil prices rise, then you make money; if they fall, you lose money.
In India, investors do not have a convenient way to make an oil-linked investment. While crude futures are traded on the commodity exchanges, those are more suitable for active traders as well as for businesses which need to hedge against oil prices. A passive investor who would like to invest in oil for the long-term without getting involved in day-to-day trading really has no avenue. This is the gap that the ICICI Prudential Oil Fund aims to fill.
The structure of the fund is somewhat convoluted. The fund is labeled a debt fund. However, this doesn’t actually mean anything. The most logical way for such a fund to be run would have been for the fund manager to invest in futures of indices linked to oil prices. However, Indian funds are not permitted to buy international index futures. Therefore, the oil fund will actually buy specially-created debt securities that will be structured in such a way that their total return tracks oil prices closely. To be precise, the returns will be based on the returns generated on the New York Mercantile Exchange (NYMEX) by trading in the futures of West Texas Intermediate crude. In effect, this is a commodity fund and the debt fund in the name is just a by-product of this structure. Investors can expect their returns to match oil prices quite closely.
I expect there to be some deviation because of costs and other factors, but broadly, if the price of oil is up 20 per cent, you can expect your investments to be up by 20 per cent, give or take a few. And, of course, vice versa.
Which brings us to the question of what kind of risks does this fund face. The main risk is obviously that of a crash in oil prices. Oil may have been a no-brainer when it was down to $30 or so, but not so now. There is also a currency risk added to it. The returns will be earned out of a US dollar-denominated asset and any movement in the rupee-dollar pricing could affect returns. There could also be a credit risk with the institutions issuing the debt instruments bring based on crude prices.
However, all of this said and done with — this is very much a niche fund. By no means can such a fund be considered a mainstream investment. This is an exotic investment product and should be treated as such. At the end of the day, an investor will have to take a call on what’s going to happen to oil prices. Oil has always been a tough nut to crack for investors. A precarious geopolitical balance, as well as the looming spectre of peak oil mean that to be an investor in a fund like this, you have to have a definite view on where oil is going — and you have to be right.