How to Invest in Gold ETF - Guide for Indian Investors

Introduction

Gold Exchange Traded Funds (ETFs) are simple and low-cost investment products that offer investors the flexibility of stock investment and the simplicity of gold investments. But, do you know what are the best way to buy gold ETFs in India? Gold is a commodity that is known to do well in times of political and economic uncertainty, so gold ETFs offer the perfect hedge to any portfolio. Gold ETFs trade on the cash market of the NSE. Unlike the sovereign gold bonds, which are only available 8-12 times in a year, the gold ETFs are available on tap. All that investors need is a trading account to buy the gold ETFs and a demat account to hold these gold ETFs. The gold ETF prices are closely linked to the spot price of gold in India.

Gold ETFs are passive investment instruments that are based on gold prices and invest in gold bullion. The fund manager only works to ensure that the gold ETF returns closely track the returns on spot gold. Apart from transparency, gold ETFs also bring safety because such gold ETFs are regulated by SEBI and also the units are backed by physical gold held with the custodian bank. It is fully backed and the only risk is the gold price risk in the fund. The returns on the gold ETF will be linked to returns on spot gold.

What Is a Gold ETF and How Does It Work? 

As explained earlier, the gold ETF offers a passive investment approach to investing in gold in dematerialized form. Here are some key features of gold ETFs.

a) Gold ETFs are listed products and can be bought and sold in the stock markets at NAV linked prices on a real time basis. They can be purchased through the trading account and held in custody in your regular demat account.

b) The clearing and settlement of gold ETFs happens through the normal demat clearing system. So, settlement guarantee is available on gold ETFs also, like all other exchange traded products.

c) Gold ETFs offer returns that mirror the returns on spot gold in the Indian bullion market. However, the actual returns may be lower than gold returns due to the expense ratio. Indian gold ETFs typically have average expense ratio between 0.50% and 0.60%.

d) The purity of the backed gold is guaranteed by the custodian bank so investors don’t have to worry about differences in the quality of gold. That makes gold ETF a standardized product in the market.

e) Gold ETFs are held by investors as a hedge against portfolio uncertainty since gold outperforms in times of economic and geopolitical uncertainty. It is always advisable to keep overall allocation to gold at under 15% of overall portfolio.

Most of the gold ETFs in India were launched in the aftermath of the global financial crisis, which saw appreciation of the importance of gold as an asset class. Interestingly, in the last 10 years, there have been a couple of years when gold has been among the best performing asset classes in the market. So there is a case for hedging risk with gold ETFs.

Important Factors to Consider Before Investing in Gold ETFs

Here are 6 things which should help you decide on the gold ETF investment decision.

• Returns on gold ETFs are taxable as capital gains. However, gold ETFs are treated as non-equity holdings. Hence, it has to be held for at least 3 years to qualify as long term capital gains. While short term capital gains are taxed at the peak rate applicable, long term capital gains are taxed at 20%, with benefit of indexation.

• Know the expense ratio. Ideally, the expense ratio should be in the region of around 40-60 basis points. You need to be cautious about higher expense ratios as it would deplete your effective returns on the gold ETF. In addition, there is also the brokerage and statutory charges for market linked trading.

• Gold ETFs not only reduce risk of the portfolio but also diversify risk. Gold normally has a very low correlation with the equity markets and the debt markets. It reduces concentration risk significantly.

• Most of the major gold ETFs are extremely liquid with relatively low impact costs. This reduces the risk for an investor as entry and exit can be quite simple.

• Gold ETF prices are linked directly to the spot price of gold in India. This is a function of the international price of gold and the USDINR equation. So, gold ETF carries both these risks.

• There is no option of physical delivery of gold against gold ETFs, unless you are a very large and significant investor, in which case, such options can be exercised.

Performance of Top Gold ETFs in India

If you look at the five-year returns, there is not much to choose between the gold funds in terms of returns. The variance in performance between the top performer and the bottom performer on a 5 year basis is not much. We look at some Gold ETFs in India.

1. ICICI Prudential Gold ETF (AUM Rs3,480 crore): The ICICI Pru Gold ETF offers returns that are closely linked to the spot price of gold in the Indian market and is fully backed by physical gold with custodian bank. Gold funds run the commodity risk, plus there is a currency risk element to it. The expense ratio of the fund is reasonable at 0.50% compared to other funds in the gold ETF category. The ICICI Prudential Gold ETF is managed by Gaurav Chikane.
2. HDFC Gold ETF (AUM Rs3,206 crore): This is again a passive commodity backed fund that offers returns that are closely linked to the spot price of gold in the Indian market. Gold normally gains during times of economic uncertainty and that is when gold ETFs normally give good performance. The expense ratio of the fund is reasonable at 0.59% compared to other funds in the gold ETF category. The HDFC Gold Fund is managed by Bhagyesh Kagalkar.
3. SBI Gold ETF (AUM Rs2,690 crore): SBI has been among the early entrants into the Gold ETF segment. Like the other gold ETFs, the SBI gold ETF is also backed by equivalent physical gold in the custodian bank. The expense ratio of the fund is relatively low at 0.51% compared to other funds in the gold ETF category. The SBI Gold ETF is managed by Raviprakash Sharma.
4. Kotak Gold ETF (AUM Rs2,456 crore): Kotak Gold ETF has been around since 2007 with returns almost mirroring the gold price index, adjusted for costs. The expense ratio of the fund is reasonable at 0.55% compared to other funds in the gold ETF category. The Kotak Gold Fund is managed by Abhishek Bisen.

Conclusion: Is Investing in Gold ETFs Worth It?

The advantage of gold ETFs is its simplicity and its liquidity. However, investors must keep a tab on their exposure to gold as an investment asset class. While there are no hard and fast rules, the global benchmark for retail portfolios is to allocate between 10% to 15% to gold.