Gold ETFs gain favour; choose ones with low cost, minimal tracking error

About 95 per cent of India’s gold demand is in the physical form. Over the past years, however, holdings in gold exchange-traded funds (ETFs) have surged over 200 per cent  —  from around 21 to over 63 tonnes  — attesting to their growing popularity.

 

Gaining traction

 

Gold’s strong performance — a return of around 32 per cent over the past year — has been a key driver. “The post-pandemic world has been marked with uncertainty on the macroeconomic and geopolitical front. This has kept gold, considered a safe haven in times of risk aversion, relevant. Inflation has been on the higher side, making investors prefer a long-term inflation hedge like gold,” says Chintan Haria, principal–investment strategy, ICICI Prudential Mutual Fund.

 

Volatility in the equity market led to domestic flows going into gold. “It has delivered both stability and returns in recent times,” says Niranjan Avasthi, senior vice president, Edelweiss Mutual Fund.

 

Central bank buying has lent further support. “Central banks want to diversify from US Treasuries, which constitute approximately 60 per cent of global reserves,” says Sapna Narang, managing partner, Capital League.

 

More investors now adhere to the principle of asset allocation. “Increasingly, they treat gold as a financial asset in their portfolio rather than just as jewellery,” says Vikram Dhawan, head of commodities and fund manager, Nippon India Mutual Fund.

 

Avasthi points out that investors have also turned to ETFs due to the government halting fresh issuance of sovereign gold bonds (SGBs).

 

Purity and liquidity benefits

 

Investors do not need to worry about purity here. “Gold ETFs only invest in gold of the highest purity, taking care of the purity-related concern often associated with physical gold,” says Haria.

 

They are easy to transact. Narang points out that buying a gold ETF is like buying equity  —  it can be done at any time within trading hours.

 

Security is another positive as the underlying gold is stored in vaults while the gold ETFs are held in electronic form in the investor’s demat account.

 

With fund houses making sub-one-gram denominations available, they are also affordable.

 

Watch out for tracking error

 

Tracking error is one possible drawback. “The ETF’s performance may not perfectly track the price of gold,” says Narang. A high expense ratio would also erode returns.

 

Dhawan warns that since these are market-traded instruments, investors are exposed to volatility. Prices can also be affected by customs duties and other levies. Opening a demat account is essential. Avasthi cautions that ETFs do not generate income and their returns depend solely on gold’s price movement.

 

Choosing the right ETF

 

Focus on cost. “The expense ratio should be moderate: Lower cost leads to better long-term returns,” says Avasthi.

 

Haria suggests opting for ETFs with high assets under management and trading volumes to ensure ease of buying and selling.

 

Narang suggests opting for an ETF that closely tracks the price of gold.

 

Gold ETF vs gold fund

 

Gold ETFs allow intraday trading. “This makes them ideal for active investors, portfolio managers, and arbitrageurs,” says Dhawan.

 

Gold funds invest in ETFs and allow end-of-day transactions at net asset value (NAV). “They are suitable for investors who do not have a demat account and are seeking exposure to gold through a mutual fund structure,” says Narang. Those wanting to invest via a systematic investment plan (SIP) should consider this route. However, gold funds have a slightly higher expense ratio than gold ETFs. 

Tax rules for ETFs, MFs & physical gold

 

> Capital gains from gold ETFs held for over 12 months are classified as long term and taxed at 12.5%

> Gains from gold funds and physical gold are considered long term after 24 months and taxed at same rate

> Short-term capital gains (STCG) for all three — gold ETFs, gold funds, and physical gold — are taxed at the investor’s income slab

> Physical gold carries additional costs such as 3 per cent GST on purchase, and significant making charges for jewellery