The Hindu Business Line : More for diversity than high returns

Gold Exchange Traded Funds (ETFs) have certainly not turned out to be a runaway hit in the Indian market, managing combined assets of less than Rs 400 crore by end-October. However, investors who own a portfolio of equity funds should consider adding gold to their investments as a diversification measure. Periods of turmoil in the equity, commodity or debt markets usually see gold performing well as an investment option. Taking the ETF route to investing in gold today app ears to be the easiest and most cost-effective way for investors to add gold to their portfolio. Key factors to consider:

Why invest: Gold ETFs allow you to acquire gold in paper form with a relatively small outlay. By taking the ETF route, investors can sidestep the carrying costs, wastage and making charges usually associated with purchasing and holding gold in its physical form.

In a Gold ETF, your investment roughly replicates the returns generated by gold in dollar terms, based on its London prices. There could be a marginal difference between the returns on the ETF and that on physical gold, due to “tracking error”. This is caused by transaction costs and expenses incurred by the fund house in managing the ETF.

Unlike other mutual funds, Gold ETFs can be bought, not from the fund house, but from the stock exchange where their units are listed. The price at which a gold ETF trades is closely linked to its underlying NAV, usually declared daily by the fund house.

Returns: As Gold ETFs are passive funds that track international gold prices, their returns will merely mirror the latter. The three gold ETFs that have been in operation for a while — Kotak, UTI and Benchmark — sport roughly similar returns of about 16.5 per cent over a three-month period. Gold ETFs, over this period, have underperformed the Sensex (25 per cent) as well as the average diversified equity fund (28 per cent).

Five and ten-year returns on gold are also significantly lower than those generated by diversified equity funds. This suggests that Gold ETFs should be held by investors who already own equity funds, to tide over periods of uncertainty in the commodity or equity markets.

Broadly, gold may deliver high returns in the event of continued weakness in the US dollar, an unexpected spike in crude oil prices or sustained high inflation. Allocations to Gold ETFs may be restricted to 5-10 per cent of your portfolio.

Expenses: Investors need not shell out any entry or exit load when they buy or sell Gold ETFs after the NFO. The key costs incurred in investing in a Gold ETF are the brokerage charges levied by your broker when you place a buy or sell order for an ETF and the annual expense ratio charged by the fund, towards management and operating expenses. The latter is automatically adjusted in the NAV. The expense ratio now levied by Gold ETFs is at 1 per cent per annum.

Taxation: Gold ETFs are treated akin to debt-oriented funds for taxation purposes. No securities transaction tax is charged when you buy or sell ETF units, as they are treated as debt funds. The return earned on a Gold ETF is subject to short-term capital gains tax at the applicable slab rate, for investments held for less than a year. They are treated as long-term capital gains and taxed at 10 per cent if held for over a year.

Liquidity: Like closed end funds, investors have to sell their Gold ETF units through the stock exchanges at the prevailing traded prices. Your ability to transact in ETF units will depend on the trading frequency and volumes recorded by the ETF in the markets. Daily trading volumes for the Gold ETFs that are currently listed have swung sharply between 1,500 units and over 30,000 units per day over the past few weeks.

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