What is a Commodity Hedge Fund?

A commodity is a type of product that is the same regardless of the producer. Examples of commodities are metals such as gold and silver or agricultural products such as wheat and sugar. A hedge fund is an investment vehicle that attempts to share investment risk among a limited number of investors. A combination of the two ideas yields a commodity hedge fund, which has a purpose of commodity investment among a limited number of investors.

A commodity hedge fund is established with a specific number of investors. The investors hire an investment manager to direct the investments of the fund. Fund managers typically are paid a management fee of approximately 1 to 2 percent, plus a performance fee that is tied to the profitability of the fund. The performance fee gives the fund manager an additional incentive to produce a high level of profitability.

The initial investment in a hedge fund is usually substantial. There is a large amount of capital needed, so many hedge fund investors are institutions. Some hedge fund agreements specify a minimum length of time that the initial investment must remain in the fund.

Commodity hedge fund managers look at investments with a shorter focus than a typical mutual fund that is based on long-term views. A hedge fund manager tries to earn money whether the market is rising or falling. Commodities might offer a hedge against inflation, because they have a tendency to rise in price during an inflationary cycle.

Commodity traders look at a range of economic events that might affect a commodity. For example, if a region that grows a huge amount of wheat is hit with heavy rains and flooding, commodity traders might expect that the price of wheat will increase because of the damages caused by the weather conditions, reducing the amount of wheat available for sale. A commodity hedge fund manager might look at an unstable economic market and a devalued currency and interpret that the price of gold or silver would be likely to climb because of investors who are worried about the stability of the market. Commodity hedge fund managers must constantly evaluate market conditions in order to respond effectively by buying or selling in response to rapidly changing market conditions.

Public information about commodity hedge funds is limited, because they typically are comprised of private investors. Regulatory oversight also might be limited because of the private nature of the funds. Hedge funds face increasing scrutiny from regulators worldwide because of the high-risk nature of the investments and the huge amounts of money involved.