In a bid to monetise retail gold holdings, the Unit Trust of India will launch its maiden gold index fund in the first quarter of 1999. The Gold Index fund will be a closed-ended scheme with a duration of five years.
"UTI is currently working out the risk containment strategies, which would involve swapping gold for dollars. We will soon approach the finance ministry and the Reserve Bank of India for final clarifications and clearances before launching the scheme in the first quarter of next year," said P J Nayak, executive trustee of UTI.
Nayak said the fund would yield macro-economic benefits. "Not only will gold lying idle be monetised and used for productive purposes in the economy but the scheme will also help to restrain current demand for future consumption as investors will have the option of buying the gold index fund instead of buying gold now for future use," he said.
The gold index fund is being targeted at retail individuals who either have gold sitting in lockers or buy gold regularly for future consumption.
Another huge potential investor base is religious trusts, which receive considerable amounts of gold as offering from devotees. UTI hopes to collect around 200 tonnes of gold.
Investors will be given an option of investing either gold or cash into the scheme.
However, the fund has not taken a decision about whether only bars will be accepted or jewellery too. Units will be issued at the cash equivalent of the gold price on that day.
UTI will then swap the gold into dollars with an international financial institution for the duration of the scheme. Two international banking institutions that deal in bullion have already been short-listed as the intermediaries. The same institutions will help UTI collect and measure investors' gold for weight and purity on site at select UTI branches across India. The gold will then be transferred overseas for swapping into dollars. The current rates for gold to dollar swaps are sub-Libor.
To avoid any credit risk on the dollars, as they will be swapped back into gold at the end of five years, UTI will invest the dollars in risk free securities or in instruments with minimum credit risk. One option being considered by the UTI is to lend the dollars to prime Indian corporate borrowers with a AAA rating for five years.
"Even prime corporates borrow dollars at a spread of at least 300 to 400 basis points over Libor presently. UTI will be able to lend dollars at more attractive rates," said Nayak.
At the end of the five years, the gold will be returned to the investors along with a terminal appreciation return of around 10 to 15 per cent. UTI officials stressed that this is not an assured return and would depend on the returns earned by investing the dollars.
UTI officials feel that they can go ahead with the scheme as they have worked out ways to mitigate the various risks through swaps. Studies have also shown that there is little or no basis risk because the domestic and international prices of gold show a strong correlation.
