Gold exchange-traded funds have finally become a reality in India after the recently issued guidelines by SEBI paved their way.
This will be well received by those who have believed in gold as a lucrative investment class. In fact, Gold ETFs have already been launched by Benchmark AMC as well as UTI AMC. Given the interest of Indian households in gold and the 'psychological comfort' that gold offers, gold ETFs will offer a new and superior investment channel. Investors will be able to ride on the price movements of the asset and gradually build their positions without having to take possession of the metal and bother about its safekeeping. Further the ETF will offer liquidity as the units will be traded like shares of companies in a dematerialised form on the NSE.
If returns are anything to go by, then a little over 16 per cent yielded by gold over the past year (January 2006-2007), is not exactly whopping, but the primary benefit lies in the diversification it offers at the asset class level. The basic rule of achieving optimal diversification involves framing a portfolio where the correlation of returns between the different asset classes is low. Given that the co-relation of returns between the equity markets and gold is very low, the metal lends itself well as an effective tool for diversification. Further, gold has historically provided an efficient hedge against inflation.
Hitherto, a small investor turned either to jewellers or banks for purchasing gold. While banks provide assurance on quality, there is no secondary market for this gold. Most jewelers would buy back gold but at a high discount. Gold ETFs fill the lacunae of quality considerations, liquidity, safety and convenience in gold investing.
As per the securities watchdog, SEBI's guidelines, the gold traded here would be valued at the AM fixing price of London Bullion Market Association (LBMA) in US dollars, and the metal can be retained only in the form of standard bars which comply with the good delivery norms of the LBMA. Since the units will be traded on the exchange, unlike the open-ended mutual funds, the actual buying and selling price may quote at a premium or discount to the net asset value. However, the difference in the traded price and NAV is not likely to be very large. Further, the NAV will be vulnerable to exchange rate movements, changes in indirect taxes such as custom duties and VAT. While there will be no entry or exit loads, investors will have to bear brokerage charges.
Till the time stock markets keep performing the way they have been, gold ETFs may not generate a lot of investor interest. But if equities hit a rough patch, these funds may offer succor.