Runaway prices of bullion give gold ETFs that extra glitter

Exchange-traded funds (ETFs) have been one of the more original concepts evolved in the mutual fund (MF) industry. The concept, popular globally, is increasingly attracting interest in the Indian markets as well.

Over the years, there is an increasing awareness of gold as a financial asset. With India being the largest consumer of gold, coupled with the benefits of ETF, it was only natural that gold ETFs were accepted by the Indian investor.

Retail investors too, have started investing in gold online rather than holding it in physical form. As the investment awareness is rapidly increasing in the middle-class families, there is a huge demand in gold investment in the form of ETFs.  

Gold ETFs have provided investors a means to participate in the bullion market without the necessity of taking physical delivery of gold. ETFs, as the name suggests, allows investors the ability to trade their holdings in the stock exchange.

In investment parlance, gold ETF would be a passive investment; so, when gold prices move up, the ETF appreciates and when gold prices move down, the ETF loses value. They have made investing in the yellow metal very convenient and inexpensive.

Investment in gold is considered as best way to hedge against inflation and uncertainty lower the risk and insure the portfolio. Small allocation (5-15%) of gold brings in the much needed consistency to portfolio performance. Gold does not require any economic or political stability to exist.

The gold ETFs have been benchmarked against the prices of physical gold and gold prices are closely linked with two important factors: the USD and crude oil prices. While gold has an inverse relationship—strong negative correlation—with the USD (i.e. the prices of gold rallies as the dollar falls and vice versa), it has direct link with the oil prices. There is an ever widening gap between gold demand and supply due to ever increasing demand on the one hand and limitations on the other.

Gold ETFs have been consistently generating excellent returns and becoming one of the popular investment avenues. In a move to bring in more transparency, Securities and Exchange Board of India (SEBI) has ruled that physical verification of gold underlying the gold exchange-traded fund (ETF) units be carried out by statutory auditors of MF schemes. The reports are to be submitted to the trustees of the fund house on a half-yearly basis, who, in turn, would submit it to Sebi.

One of the major factors that should be considered while comparing ETFs is tracking error. ETFs are supposed to follow movement of a particular indices or a commodity price (like prices of gold as in case of gold ETFs). Any deviation between the actual movement of that commodity and movement in the fund is called the tracking error. Lower the error, better the performance of the fund. In simple words, others ape the movement of the prices of gold.

Looking at some of the gold ETFs available, SBI Gold ETF, which was launched on May 18, 2009, has been one of the best performers in the category. It has been managed by Arun Agarwal.
In one year, it has fetched 28.09% compounded annualised returns. Reliance Gold ETF, which is managed by Hiren Chandaria, has generated 23.48% compound annual growth rate (CAGR) returns, since its inception on November 21, 2007.

UTI Gold ETF has given 27.97% and 24.33% compounded annualised returns for one year and three years tenure, respectively. The scheme is one of the oldest gold ETFs in the market and is managed by Swati Kulkarni. Even for short term duration, gold ETFs have generated double-digit returns. While choosing a gold ETF, we also need to consider the expense ratio attached to the scheme.

A scheme with a lower expense ratio will be preferred over the higher ones. In a short span of one year, gold prices have risen more than 30%. On April 29, 2010, the price of gold stood at `16,995 for 10 grams while on April 29, 2011 it was at `22,145 for 10 grams. The value appreciation in gold is huge, which is replicated in its ETFs as well.

To conclude, one can easily say that allocation in gold must be a part in an investor’s portfolio as it helps in diversifying risk and is considered as a safe haven at times of economic turmoil, high inflation and political instability.