While many of us believe in buying gold in the form of coins and ornaments, investors are increasingly looking at exchange traded funds (ETFs) with gold as the underlying asset.

The reasons are straightforward. One, when you buy a unit of an ETF you get to buy gold of certified purity at prices closest to the prevailing international prices, at the current exchange rates. The only additional cost you incur is brokerage. When you buy jewellery, you may be paying a premium over international prices on account of design, making charges, wastage as well as lower caratage. Therefore, ETFs replicate gold price returns much better than jewellery.

Two, in an ETF the asset is held in electronic form. This saves you from the hassle of scouting for a safe deposit locker to safeguard your gold. You can also enjoy your summer vacation without having to worry about the gold kept in your almirah. It circumvents the risk of theft or loss.

Three, selling ETFs is easy as there is a transparent quoted price for each unit. As ETFs are traded in the stock market, they can be converted into cash faster than physical gold. In jewellery, you may suffer deductions on account of wastage. But liquidity may vary across ETFs issued by different fund houses. So it is important to stick to ETFs with higher liquidity.

But, there are some drawbacks too. ETFs are listed on the stock exchange, and hence are subject to volatility due to daily fluctuations in their quoted price.

So one, liquidity has a bearing on the price of the ETF. The quoted price of the ETF on the exchange may vary from the net asset value (NAV) disclosed by the mutual fund. For instance, if there are more buyers, strong demand for the ETF can drive up the price, way higher than the NAV.

Two, you need to hold a demat account to trade in ETFs, though opening one is not a very expensive or time consuming proposition. Also, given the wild intra-day swings in the price of ETFs, timing the market may require requisite expertise.

Consider funds

For investors who are not accustomed to trading in the stock markets, gold savings funds managed by mutual funds are an option. If you do not hold a demat account, yet want to buy gold in electronic form, you can consider gold funds.

In a gold fund, the fund house pools the money from public and invests them in ETFs. So the difficulty of timing the purchase or sale of an ETF is done away with. You can buy or sell the gold fund at the applicable NAV disclosed by the mutual fund.

You can even set up a systematic investment plan in gold funds so that a specific sum of money is invested in gold funds at a certain date. That can help you ride out wings in gold prices without taking on the risk of bad timing. This is harder with an ETF, as you will have to do the purchase or sale transaction yourself or try for a SIP through the online platform.

The convenience of gold savings funds, however, comes at an additional cost.

The management fee for gold savings funds is typically higher by 0.5 to 1 percentage points, compared to an ETF. Hence, the returns on gold savings funds will be lower to the extent of the incremental management fee.

For instance, let us compare the returns of HDFC’s Gold Fund (growth) and HDFC’s Gold ETF. On a year-to-date basis, HDFC Gold ETF has delivered 14.2 per cent return, 1.1 per cent higher than the HDFC Gold Fund. Similarly, in the case of Axis Mutual Fund, the ETF has delivered 0.9 per cent higher returns during the same period, compared to its gold savings plan.

But there are exceptions too. Some gold funds have managed to register returns closer to their ETF returns. For instance, Reliance Mutual Fund’s gold savings plan has delivered 12.2 per cent for the period January 1-December 6, as against 12.5 per cent return for its R* Shares Gold Exchange Traded Fund, over the same period.

Nalinakanthi.v@thehindu.co.in

(This article was published on December 8, 2012)
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