Consider a situation where a sophisticated HNI client asks you why gold or crude oil futures are trading at a discount compared to the spot price, despite your earlier explanation that futures usually trade at a premium to cover carrying costs. You might find yourself in a tight spot if you simply fall back on the textbook Cost of Carry model.
In the Indian markets, particularly with physical commodities or assets in high demand, this classic model occasionally breaks down because it treats the asset merely as an investment vehicle rather than a physical necessity for the holder.
This phenomenon is known as convenience yield. When an asset is in short supply, holding the actual physical stock provides a benefit that a paper contract cannot replicate, such as the ability to maintain production lines or fulfill urgent orders. Because the owner of the physical asset gains this operational advantage, they are willing to hold the asset even when the futures price is lower than the spot price plus financing costs.
For a distributor, understanding this is essential when explaining why certain commodity-linked strategies or hedge fund-style SIF mandates might exhibit price patterns that seem to defy simple arbitrage logic.
When you are performing a suitability assessment for an investor looking at SIF strategies that include commodity derivatives, you must account for these non-linear pricing behaviors. A client expecting the market to follow a standard interest-rate-based pricing model may be caught off guard by backwardation, where near-term prices are higher than long-term prices. Failing to explain that these price gaps often reflect supply-demand dynamics rather than market inefficiency can lead to poor investor expectations and unnecessary complaints.
Your role is to bridge this gap by educating the client that these derivative markets are not merely ‘cost-plus’ arrangements but are deeply influenced by the physical realities of the underlying goods.
Applying this knowledge protects you during the onboarding process and ongoing servicing, especially when managing the ₹10 lakh minimum investment threshold requirement for SIFs. By positioning yourself as an advisor who understands the limitations of simple models, you reinforce the client’s trust in your expertise.
Always remember that when the Cost of Carry model fails to explain a price discrepancy, it is usually because the market is prioritizing the immediate utility of the asset over the theoretical cost of holding it. Grounding your advice in these real-world market mechanics is what differentiates a qualified distributor from a mere order-taker.
Nuance
Check Your Understanding
An investor notices that the futures price of a physical commodity is lower than the spot price. As a distributor, which explanation should you provide regarding this ‘backwardation’ market?
A client asks why their SIF strategy focusing on physical metals shows returns that don’t align with the simple ‘spot + interest’ pricing. Which factor is the most likely driver?
This is a companion read for Section 15.7 — Futures pricing from Pass Certification Examination for Mutual Fund - Specialized Investment Fund Distributors by Akhilesh Gururani, available on Amazon Kindle.
Copyright © 2026 Akhilesh Gururani. All rights reserved.