Gold is regarded as a natural hedge against inflation and currency depreciation. Moreover, the recent volatility in the global financial markets has brought the focus back to the yellow metal as an investment option. As such, gold is generally considered to add stability to an investment portfolio, which is useful during times of market volatility.
Even during the Covid-19 pandemic, gold had outperformed the markets initially against the market corrections in equity with around 50% returns over a year from August 2019 to August 2020. Hence, it makes sense to have some allocation towards gold in an investment portfolio. However, buying, storing and selling actual gold may be cumbersome and pose security risks.
With the financial markets evolving, investing in gold is not limited to buying jewellery, coins, bars, etc. Instead, one may consider buying gold digitally through mutual funds structured as Gold Exchange Traded Funds (ETFs). Being digital investments by nature, Gold ETFs make it easier and more convenient to make such investments. This article discusses Gold ETFs as an option for those considering investment exposure to gold.
What is a Gold ETF?
An ETF is an investment option that tracks an underlying index/security. It provides returns to investors based on the underlying index/security returns. ETFs can track different equity indices like S&P BSE Sensex, NSE Nifty50 or debt indices like SDL Indices, or commodities like gold, silver etc.
Gold ETF, as an investment product, generates returns for investors based on the prices of physical gold. The fund house invests the ETF assets in physical gold bullion, etc. Any changes in the value of the physical gold are passed to the ETF valuation. Thus, investors have a simplified method for investment exposure to the yellow metal through Gold ETF. Gold ETF units are listed and traded on stock exchanges like any other listed security, and the investors may buy and sell units of Gold ETF through stock exchanges and hold such units in Demat accounts.
Why should you buy a Gold ETF?
Portfolio diversification across asset classes helps in long-term wealth creation. Further, gold generally tends to correlate negatively with other asset classes like equity & debt and is usually considered a safe haven. It has consistently served as a hedge against inflation in the long term and may absorb market corrections to provide stability to the portfolio. It makes sense to diversify through investment in gold, and the Gold ETF offers a convenient mode to do just that.
How Gold ETFs work
Gold ETFs are like other mutual funds with investments into gold as the underlying security. Here is how a Gold ETF typically works:
Creation of ETF units
The mutual fund creates Gold ETF units with physical gold as the underlying security. These units are listed on stock exchanges (NSE & BSE) for buying and selling by investors.
Trading of ETF units through stock exchanges
You may invest in Gold ETFs by putting buy/sell orders for ETF units through the stock trading account. The units will be credited to/debited from your Demat account, just like a standard stock.
Valuation changes of ETF units
Since the underlying investment for the ETF units is physical gold, any changes in the gold value will drive the changes in the NAV of the Gold ETF. However, there may be some variation in the secondary markets, that is, units traded on the stock exchanges due to the demand and supply of Gold ETF units and the demand and supply of physical gold in the market in domestic and global markets.
Who should invest in Gold ETF?
Investors who want to allocate a part of their investment portfolio to the yellow metal can consider investing in Gold ETFs owing to its inherent convenience over physical gold. While Indian households vastly prefer gold as an asset class in physical form, Gold ETFs make it convenient for investors to hold it as an investment. Some of the additional benefits of Gold ETFs over physical gold are discussed ahead.
Why invest in Gold ETF
1. Ease and convenience
Investors may buy and sell Gold ETF units with a click of the mouse, wherein the transactions are traded through stock exchanges on a real-time basis. No security & storage costs – While the investors hold such units in Demat accounts, the mutual fund's underlying investment in physical gold is also made.
As such, the ETF valuation is backed by the actual investment in gold and, thus, mitigates default risk. The investment in Gold ETF units continues to be digital in Demat accounts, and the investors need not worry about the safety & storage of the investment in gold.
2. Transparent pricing
One may trade through stock exchanges in real-time, wherein the investors may see the market depth, i.e., buy and sell orders placed by different investors. Further, such prices will tend to align with the gold prices in the international markets, as the investments are backed by physical gold.
One may also track their investment valuation on a real-time basis, and such investments may also be liquidated at around the same prices subject to the demand at the stock exchange floor. In contrast, if one has invested in physical gold, the transaction pricing is contingent upon the fairness of the other party.
3. No risk of impure gold
When one invests in physical gold, there remains a risk that gold's purity may be compromised, as trade quality depends upon the widespread market participants. Such impure gold may provide lower realisation when one tends to liquidate such investments or utilise them in making jewellery etc.
Impurity risk is eliminated in Gold ETFs as the investment in underlying gold is made with recognised vendors only after professional due diligence and quality checks for internationally acceptable hallmarked gold.
While it is prudent to diversify the investment portfolio through gold, one must always remember the principles of diversification & optimal asset allocation.
How to invest in Gold ETF
Buying and selling Gold ETFs can be done through the primary market i.e. through an asset management company (AMC) directly in the creation unit size (basket of fixed number of units) or through secondary markets i.e through stock exchanges in log size of 1 units and multiples thereof.In secondary markets, if one needs to sell/redeem Gold ETF units, a sell order must be entered for ETF units through the demat trading account. The order must specify the number of ETF units being offered to sell and the price at which the investor is offering to sell. The order may be a market order or a limit order. A market order means that the order would be executed at the prevailing market price.
In contrast, a limit order specifies the minimum selling price at which the investor is willing to sell their Gold ETF units. In case the market price reaches the specified limit price, the order is executed. However, if the specified limit price is not touched, the order is cancelled at day end and the investor will need to place another order on the next trading day if required. The ETF units will be debited from the Demat account, just like normal stocks.
Documents required to open Demat and trading account
Since investment in Gold ETFs can be made only through Demat accounts, one needs to have a Demat account. Apart from the detailed Demat and trading account application form, the following documents are required for account opening:
PAN
PAN (Permanent Account Number) is required for KYC validation before opening the Demat account. PAN acts as centralised and unique investor information in the Central Record Keeping agency (CRA) and accordingly fetches all the linked information for incorporation in the new account.
Identity proof
Investor needs to submit Proof of Identity which can be Aadhaar card, driving license, passport etc. If the investor has submitted physical PAN card copy, the same is also accepted.
Proof of address
One must also submit proof of address, wherein all the documents and correspondence should be addressed. Further, the investor will also receive the delivery Instruction Slip (DIS) at the registered address, which will serve as cheque book for the demat account.
Benefits of investing in Gold ETFs
Defensive investment option
Gold is generally considered as a defensive investment option, which not only hedges against inflation but is also favoured during times of risk-off sentiments. As recently as March 2022, gold has seen sharp rallies as the geopolitical tensions intensified across Asia-Europe region. As such, it makes sense to make partial allocation of the investment portfolio in gold. Gold ETFs being in nature of digital investments make it easier and convenient to make such allocation.
No worries for storage & safety
ETF units are traded in digital form through the demat account. As such, the investors do not have to worry about the storage & safety of the gold investment. In contrast, in case of physical gold, one often needs bank locker or safes for the asset’s custody.
Cost-effective manner of investing in gold
The NAV of Gold ETFs moves in line with the movements in benchmark gold prices and may be considered as an alternative to the investment in physical gold. Further, the investors do not need to incur additional costs, e.g., quality inspection charges, minting/ making charges, locker charges for the safe custody of gold, etc. and may monitor the investments through their demat accounts directly.
No exit load
Unlike several mutual fund schemes, there are no exit load implications even if the investor wants to liquidate the investments shortly after making an investment.
Risks of investing in Gold ETFs
Systematic risk
This refers to the risks of adverse changes in the valuation of the ETF units, which may result due to a decrease in the physical gold prices. If the prices of physical gold decrease, the valuation of Gold ETF units will also lower.
Liquidity risk
The liquidity of ETF units on stock exchanges is a crucial parameter for an investor, since in the absence of natural buyers and sellers at all point of time, an investor may not be able to sell the Gold ETF units at the market prices and forced to sell units at lower prices to generate sufficient demand. This difference between the market value and the transaction value is called the impact cost.
Gold versus Gold ETFs
Here is a brief comparison between physical gold and Gold ETFs:
| Particulars | Physical Gold | Gold ETFs |
| Charges and Transaction Costs |
Minting, making and wastage charges make up a higher proportion, thereby making the effective investment in gold lower |
Cost-effective as transaction costs are pre-determined and minimal |
| Safety of Investment |
Arrangements must be made for safe custody like bank lockers |
Investment is held in a digital demat account and thus, secure |
| Quality Concerns | The quality of gold has to be verified to ensure proper value for the invested amount |
No concerns on the quality of investments, as they are in digital form |
| Convenience to Invest |
Investment needs to be made through jewellers/stores etc. |
Most convenient, as the investment can be made online |
| Transaction Price |
Pricing may be different from city to city |
Transparent and real-time pricing through stock exchanges |
Conclusion
Gold ETFs are thus ideal for those who are looking to invest in gold for convenient investment and portfolio diversification. It more straightforward option for investing in gold without worrying about the safety and quality of the yellow metal. Additionally, it is convenient to invest in Gold from the comfort of one’s home, as the investments may be done online through stock exchanges.
Along with suitable investments in debt and equity, the allocation of gold may be kept within 10% of the total portfolio.
Disclaimers: The information set out above is included for general information purposes only and is not exhaustive and does not constitute legal or tax advice. In view of the individual nature of the tax consequences, each investor is advised to consult his or her or their own tax consultant with respect to specific tax implications arising out of their participation in the Scheme. Income Tax benefits to the mutual fund & to the unit holder is in accordance with the prevailing tax laws as updated for the Union Budget 2022 presented in the Parliament in February 2022. Any action taken by you on the basis of the information contained herein is not intended as on offer or solicitation for the purchase and sales of any schemes of UTI Mutual Fund. Please read the full details provided in SID and SIA carefully before taking any decision.
UTI AMC Ltd is not an investment advisor, and is not purporting to provide you with investment, legal or tax advice. UTI AMC Ltd or UTI Mutual Fund (acting through UTI Trustee Company Pvt. Ltd) accepts no liability and will not be liable for any loss or damage arising directly or indirectly (including special, incidental or consequential loss or damage) from your use of this document, howsoever arising, and including any loss, damage or expense arising from, but not limited to, any defect, error, imperfection, fault, mistake or inaccuracy with this document, its contents or associated services, or due to any unavailability of the document or any part thereof or any contents or associated services.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
Gold ETFs are exchange-traded funds that invest in physical gold and trade on stock exchanges. They offer transparency, easy liquidity, and eliminate storage hassles, making them a convenient alternative to physical gold.
