Compared with other complex products that the mutual fund industry offers, gold ETFs (exchange-traded funds) may seem quite simple. Each gold ETF unit represents a fixed grammage of gold at the time of its issue. Thereafter, its NAV moves up and down with gold prices in the market. In theory, therefore, selecting the right gold ETF shouldn’t be hard at all. But in practice, there are three quirks of gold ETFs that investors need to be aware of, to make the right choice.   

Divergent prices

Indian investors track gold prices very closely. Therefore, when buying gold ETFs, they expect their NAV to mirror the market price of gold. If the market price of 24-karat gold is ₹60,510 per 10 gram, they expect a gold ETF unit (which usually represents 0.01 gram of gold) to report an NAV of ₹60.5 per unit.  

But the NAVs of gold ETFs vary quite widely from this theoretical price. On July 12, when the gold price in the Indian market was ruling at ₹60,510 per 10 gram, the NAVs of gold ETFs (regular plans) ranged from ₹49.94 per unit for Quantum Gold ETF to ₹58.66 per unit for DSP Gold ETF. Does this mean that Quantum Gold ETF is cheap and must be bought, while DSP Gold ETF is expensive? Not at all.  

Also read: Investor interest in Gold ETFs surges as uncertainty looms; inflows of ₹124 crore in April

The NAVs of gold ETFs diverge from the market price of gold and from each other on two counts. One, gold ETFs, like other funds, charge an annual fee or total expense ratio (TER) to manage your money. TERs for gold ETF regular plans currently range from 0.21 per cent to 0.79 per cent. As the TER is deducted from the NAV of your gold ETF every year, the NAV diverges from the market price for 0.01 gram of gold. The longer an ETF has been around, the more its NAV will diverge from the original gold price. A brand-new gold ETF may start out with a NAV of ₹60.5 per unit mirroring the price of 0.01 gram of gold. But if it has a TER of 0.50 per cent, its NAV would be ₹58 (₹60.5 minus 0.5*5) five years later, even if gold prices are exactly the same. Therefore, when buying gold ETFs, it is best to buy the ones with low TER, and not the ones with low NAV.

Two, to meet redemption demands promptly, gold ETFs are allowed to hold cash and money market instruments up to 5 per cent of their assets. This also prevents NAVs from exactly mirroring gold price moves.

Tracking difference

Gold ETFs can also deliver lower returns than their benchmark (the physical gold price) due to what is called a tracking difference. The tracking difference is the difference between the returns on any ETF and its benchmark. Apart from TER and cash holdings, gold ETFs develop a tracking difference due to portfolio churn. A gold ETF owns physical gold against every unit it has issued. So if it faces large outflows, it may be forced to liquidate its physical gold holdings at prices that don’t exactly match the benchmark price of gold. A gusher of inflows may force it to pay a higher purchase price.  As of July 12, the five-year CAGR on gold ETFs ranged from 11.8 per cent to 13.3 per cent, while domestic gold price returns stood at 13.9 per cent.

Also read: Are Gold ETFs losing their glitter?

So, when choosing a gold ETF, look for one with minimal tracking difference over a suitably long time frame, such as five years. All fund houses are required to disclose their ETFs’ tracking differences on their website.

Price/NAV variance

As retail investors, you buy or sell ETF units only through the exchanges. The secondary market price of an ETF can stray off its NAV too. Whether market prices move into a premium or discount to the ETF’s NAV is a function of demand and supply. When gold is the flavour of the market, ETF prices may move into a premium to their NAV (which is their true worth). When they are out of fashion, they may sink into a discount. Buying an ETF at a discount to NAV is preferable to paying a premium. You can check out prices relative to NAVs on the NSE website.

Market prices may also fail to track NAVs for gold ETFs that feature very thin trading volumes on the bourses. On July 12, of the 13 gold ETFs listed on the NSE, five saw a traded value of less than ₹10 lakh. The most traded were Nippon Gold Bees (₹14.4 crore) and HDFC Gold ETF (₹2.4 crore). Higher liquidity usually results in a lower gap between NAV and price, apart from easier entry and exit for investors.

Take note
Market prices may fail to track NAVs
Choose a gold ETF with minimal tracking difference over long time-frame
Allowed to hold cash and money market instruments to meet redemptions
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