Gold ETFs: It’s the glitter of the yellow metal on paper
Suresh S
& T Madhavan
GOLD exchange-traded funds (ETFs)
topped the charts of mutual funds in terms of returns for the fortnight ended
May 2008. At a time when stock markets are in doldrums, the performance of gold
ETFs reaffirms the belief that gold is a valuable
complement to add in a portfolio consisting of equities.
Gold ETFs have made an entry
into the Indian mutual fund market only for about two years or so. Only five
fund houses have offered this product and going by the assets under management
(AUM) of these fund houses in terms of absolute values, these products are not
yet popular. But there can be little doubt these products are destined to come
into their own. All five gold ETFs in
Are gold ETFs investments in
gold? In the traditional sense, no. An investor in ETF
is neither entitled to receive gold nor does he sell ETFs
to get gold nor can he exchange ETFs
for gold. The investor merely has a paper investment in the ‘equivalent’ of
gold. They are listed on the NSE and can be purchased and sold on the NSE as
though you are dealing in the gold bullion market, but without trading
physically in gold. The fund house would buy gold in the bullion market to the
extent of his investment at the spot price and when he sells it would sell that
quantity in the bullion market and give him the proceeds calculated at the spot
price.
Therefore, the investor invests indirectly in gold but
never gets to possess the metal physically. Because he never gets to have it
physically, the hassles of physical possession are not there.
Gold ETF buyers are pure ‘investors’ who seek a return
out of their investment without any other motivation such as beautification or
social status or love of possessing physical gold. It is as specialised
an investment as an investment in sectoral mutual
funds such as in infotech or FMCG. In fact, it is
even more specialised because an investor in infotech or FMCG holds a basket of investments in different
IT or FMCG companies and is driven by the desire to invest in the ‘IT industry’
or ‘FMCG industry’. In case of gold ETFs, the
investment is not only not in an industry, it is not in a basket of products, it is only in one single product — gold. The
commodity gold is the ‘standard’ gold bullion 0.995 purity.
Taken then as a pure investment instrument, what would
the investment objectives for the investor be?
The returns from investing in gold have been considered
for a period of 10 years (Jan 1998 to May 2008) and are based on the daily
Next, the volatility as measured by standard deviation for gold has been
compared with the Sensex. Thus, gold also has fairly
high volatility, although it is less than the Sensex.
How good is gold a ‘hedge’ against the stock markets? To assess this, a study
has been done of the correlation coefficient of gold with the Sensex.
The correlation of return for the entire period of 10
years is 0.071 which is very low. When gold does ‘very well’, the Sensex does not do ‘that well’ and vice-versa. However, the
relationship is not negative. Hence, gold does not conclusively act as ‘hedge’.
There are, however, points uniquely in favour of Gold ETFs:
Tracking errors are expected to be low.
One special reason how gold units
score over physical gold is from the wealth tax angle. If you have
‘wealth’ in excess of Rs 15 lakh,
you are liable to wealth tax. Gold held in physical form is counted towards
this figure. But when you hold it as units of mutual funds, you are outside the
ambit of wealth tax. Capital gains on units sold of such MFs,
if held for more than a year, being of long-term nature is exempt. The same
exemption applies for physical gold only if you hold for three years. This adds
to the uniqueness for MFs. Further, STT will not be leviable on sale as this is classified as a non-equity
scheme.
On the other hand, there is one disadvantage of
investing in gold ETFs. On dividends declared by the
fund houses on gold ETFs, dividend distribution tax
will be payable by investors.
Suresh S is PGP-IIMA, ACS, AICWA and is with DMS Financial Services, Chennai
as director and T Madhavan is Prof at IIM, Ahmedabad .
