What are Exchange Traded Funds?
ETF or exchange traded funds which have physical gold bullion as their underlying asset are termed as Gold Exchange Traded Funds or Gold ETFs. Gold Exchange Traded Funds are considered to be a unique class of investment products that provide investors the flexibility of stock investments along with the simplicity of purchase commonly associated with gold investments. In India, gold ETFs are traded on the National Stock Exchange (NSE) in India as well as other leading global exchanges in a manner similar to the equity stock of companies. Thus, gold ETF units can be traded and sold continuously on various global stock exchanges at the applicable market prices. Gold ETFs get their name from the fact that these ETFs are invested in gold bullion and are just one type of ETF that an investor can invest in. As a result of their investment in physical gold which serves as the underlying asset, Gold ETFs are passive investments whose value is linked to the price of gold in global/local markets. At present, Gold ETFs in India are available for investment by both individual as well as institutional investors.
History of Gold ETFs
The world’s pioneering ETF was originally a close ended fund introduced in 1961 in Canada named the Central Fund of Canada. Later on in 1983, the initial closed ended fund’s features were amended in order to create something similar to the modern day gold ETF. This fund however wasn’t a true gold ETF as it allowed investors to invest in an exchange-tradable fund that invested in both gold as well as silver bullion. The concept of the true modern day gold ETF was developed in India in 2002 by the Benchmark Asset Management Company Pvt. Ltd. in a proposal made to the Securities Exchange Board of India (SEBI). The proposal was finally approved and the first Indian gold ETF was launched in 2007 after numerous delays as well as multiple rounds of rejections by regulatory agencies. Officially, the first modern day gold ETF was launched in Australia in 2003 with the name Gold Bullion Securities. At present India’s NSE alone lists over a dozen separate gold ETFs, which are traded daily and are managed by India’s leading Asset Management Companies.
Gold ETF Vs Gold Funds
In some cases, you might find that the terms gold ETF and gold fund are used interchangeably, however this is a mistake. The two are very different financial instruments even though they might be lumped into the common category of gold investments. As mentioned earlier, gold ETF are traded on the stock exchange similar to equity stocks and bonds, hence their value is capable of changing continuously. Additionally, gold ETF are backed by actual gold, which serve as the underlying asset for the exchange traded fund.
Gold funds on the other hand do not invest in physical gold. Gold mutual funds or gold funds mostly invest in gold ETFs. In effect, gold funds also known as gold mutual funds are a derivative of gold ETFs which in turn is a derivative of physical gold. Thus gold funds are not the same as gold ETFs and can best be described as fund of fund (FoF) mutual funds which invest in gold ETFs in order to enable investors make gold investments that are managed by experts and can help investors diversify their portfolio.
Benefits of Gold ETF vs. Physical Gold Investments
The main reason for the popularity of gold ETFs is perhaps the average Indian’s interest is gold as a physical asset apart from the metal being an auspicious item to own or buy. One of the key reasons for the high quantity of physical gold assets held in India has traditionally stemmed from the interest in physical gold as an investment designed to tide over periods of economic uncertainty. As a result, gold purchases in the physical form increased rapidly after the demonetization announcement in India as well as the US housing crisis that caused global markets to crash in 2008. At present, though gold ETF investments are not capable of completely replacing physical gold buying/selling in India, they do feature various advantages from an investment point of view.
Flexibility of Investments: Gold investments through the gold ETF route can easily be bought and sold as long as the investor has the correct type of trading account in place. Moreover, the purchase and selling price are tightly regulated by multiple market watchdogs such as SEBI, which ensure that you get the best price for your investment every time. This sort of transparency is a stark contrast to physical gold purchases, which often does not require much documentation and can be easily bought from the neighborhood jeweler or from bank (gold coins/bars) as well as other types of stores including online merchants. However, when it comes to selling physical gold, it is a lot trickier and your buyer may not be providing you a fair price for the gold you are selling to him.
Low Cost of Storage: One of the problems with physical gold is the security concern associated with the investment as it might get stolen. Thus the investor needs to spend additional money to ensure availability of lockers, security systems, guards etc. in case he/she is holding gold as a physical investment. Additionally, storage of physical gold also features space constraints, something that is not applicable in case of digital gold investments such as gold ETF. Whether you store gold ETFs in the paper form or the DEMAT form, there is no issue with regards to your investment getting stolen. This is mainly because the investor is the only person who can redeem the investment and in case of lost documents, replacement documents can be obtained in lieu of a nominal fee.
No Purity Concerns: Physical gold of high purity termed as 24 karat gold, is very malleable and ductile, however, these properties also make the metal very difficult to fashion into jewelry. As a result, most gold jewelry is made using 22 karat gold which contains small amounts of impurities in the form of copper, cadmium, silver, etc. to increase the hardness of the metal such that it is suitable for being fashioned into jewelry. This however raises purity concerns which can significantly affect the value of jewelry at the time of sale by the investor. In recent years, the introduction of Hallmarked gold has decreased such problems for the most part, however a large portion of Indians still own non-hallmarked gold, which are prone to purity concerns being raised. In case of gold ETFs, no such concerns exist as the underlying gold assets are tested thoroughly by different agencies to ensure viability and authenticity, while the Gold ETF itself is not subject to any purity concerns as it is in paper or DEMAT form.
No Making Charges: Jewelers charge a making charge and a similar albeit lower charge (plus applicable taxes) is also charged in case of gold coins/bars, which is an irrecoverable cost with respect to manufacturing the physical gold investments. This is because these charges are payable over and above the actual price of gold that is chargeable with respect to the weight of the coin, bar or jewelry. This cost cannot be recovered at the time of resale as the price would be determined based on the weight of gold and no other additional criteria. Such charges are not applicable to gold ETF investments, however, as with any securities instrument, there is an expense ratio involved which may vary from one gold ETF to another. However in most cases the expense is less than 1%, which is far lower than the average manufacturing charge of physical gold bullion/jewelry.
Taxation Rules of Gold ETF
For taxation purposes, gold exchange traded funds are considered to be non-equity investments, hence taxation rules similar to debt funds apply to gold ETF investments. Short term investments in gold ETF occur if gold ETF investments are held for 3 years or less from the date of initial allotment and in this case, short term capital gains taxation rules will apply. Investments made in gold ETFs for periods exceeding 3 years from the date of allotment are considered to be long term investments hence subject to long term capital gains taxation rules. For gold ETFs, short term capital gains tax is as per the investor’s applicable income tax slab rate. Thus for annual taxable income of up to Rs. 2.5 lakhs applicable tax rate is zero; for income between Rs. 250,001 and Rs. 5 lakhs the applicable tax rate is 5% on the incremental amount; for income between Rs. 500,001 and Rs. 10 lakhs tax rate is 20% on incremental amount + Rs. 12,500 and so on. Long term capital gains made by switching or redeeming gold ETF investments after they have been held for at least 3 years are subject to 20% tax rate with indexation benefits and 10% long term capital gains tax in case indexation benefits are not availed.
Some Leading Gold ETFs in India
In the past couple of years, gold prices globally have declined as equity markets have witnessed a meteoric rise to near record levels. The falling gold prices have led to an adverse impact on the performance of various gold-based schemes including gold ETFs. However, it is noteworthy that gold being a commodity is subject to commodities cycles and thus a recovery will happen in due course. However in such bearish conditions, the best gold ETFs are ones that have witnessed lower levels of negative growth as compared to its benchmark or its peers. The following are some of the leading gold ETFs to invest in before gold prices bounce back to their previous high levels.
Canara Robeco Gold Exchange Traded Fund
Canara Robeco Gold Exchange Traded Fund is managed by Canara mutual Fund and it has been around for over 5 years having first been introduced in July 2012. Historic equity market uncertainties in 2015-2016, led the fund to witness its best period till date during the August 2015 to August 2016, when the fund provided annual returns of over 25%. In recent years, this gold ETF has been adversely affected just like other gold investments thus it has managed to contain its losses at a level of around -8%, which indicates a better ability to negotiate bearish market conditions as compared to its peers as well as its benchmark.
HDFC Gold Exchange Traded Fund
HDFC Gold Exchange Traded Fund was launched by HDFC mutual Fund in August 2010 band it grew steadily from that point on. In fact during the August 2010 to August 2011 period just after introduction, the ETF witnessed record annual growth of close to 48%, but this growth did slow down soon after as global equity markets started to recover. The crash in gold prices in the previous year has led the HDFC Gold ETF to witness negative growth of around 8.8% as compared to the category average which currently features negative growth of almost 10%.
IDBI Gold Exchange Traded Fund
The IDBI Gold Exchange Traded Fund features the stated objective of providing its investors with returns that correspond closely with the returns provided by gold bullion investments made in India’s domestic market. The small variance between performances of the IDBI Gold ETF vs. domestic gold prices is related to factoring in the ETF’s expense ratio as well as other factors such as tracking error. During its best period between August 2015 and August 2016, this ETF provided returns in excess of 30%, while the current negative growth of around 9% corresponds closely to the category average for other domestic gold ETFs.
UTI Gold Exchange Traded Fund
The UTI Gold Exchange Traded Fund is launched by uti mutual Fund and it attempts to provide its investors with returns that closely correspond to the yield and performance of gold bullion price levels. The final performance data of the scheme would feature adjustments with respect to its expenses and any tracking errors. The ETF recorded its best performance during the July 2007 to July 2008 period when it provided investors with returns exceeding 55%. The 1 year returns of UTI Gold Exchange Traded Fund have currently been recorded at the much lower level of around -9%, which indicates slightly better performance as compared to the category average during the same period.
Investco India Gold Exchange Traded Fund
Since its launch in March 2010, the Investco India Gold Exchange Traded Fund has witnessed several booms and busts. Historically, this ETF’s best performance occurred soon after its launch during the August 2010 to August 2011 period with this gold ETF recording annual return in excess of 48%. The crash in global gold prices during the previous year has led this fund to lose a large portion of these gains and the current 1 year returns of this gold ETF currently stand at around -9%. That said, as global gold prices start rising, this gold ETF is expected to show robust growth and significantly better performance in the coming years.
Table1. Table Showing ETF data across key criteria*
|ETF Name||1 Year Returns||3 Year Returns||5 Year Returns||Expense Ratio|
|Canara Robeco Gold Exchange Traded Fund||-7.89%||-0.08%||-1.97%||1%|
|HDFC Gold Exchange Traded Fund||-8.81%||0.29%||-1.50%||N/A|
|IDBI Gold Exchange Traded Fund||-9.33%||0.05%||-1.51%||0.57%|
|UTI Gold Exchange Traded Fund||-9.65%||0.16%||-1.60%||N/A|
|Investco India Gold Exchange Traded Fund||-9.79%||-0.05%||-1.64%||1%|
*The above data is for illustrative purposes only and may change depending upon various factors including current ETF unit price.