Monday, June 25, 2007

Mutual Midas Touch?

“Give me more….Gold!”
India, the world's largest consumer of gold, gobbles up around 800 tonnes per year – a massive 23% of the global gold offtake. The Indian demand for gold absorbs what the French want to sell over five years! This translates to a gargantuan 13,000 to 15000 tonnes of cumulative gold demand – a mind boggling 10% of the cumulative world mine production. With the launch of Gold Exchange Traded Funds (GETFs) by Benchmark AMC (the pioneer of the concept of GETF) closely followed by UTI AMC and Kotak AMC, India has become the seventh country in the world that has GETFs. Nearly half a dozen GETFs are ready to join the bandwagon…the
Midas Magic is being recreated…
A Guided Tour through the GETF maze
ETFs or Exchange Traded Funds are those that manage a fixed corpus representing an underlying asset — stocks, bonds or in the case of Gold ETFs — gold. The money pooled in by retail investors like you are used to buy gold from Authorised Participants (APs), who in turn, are allotted creation units - the minimum number of units that can be bought from the fund house. Each creation unit consists of about 1,000 units (1 Kg) of GETF. The gold is stored by a custodian on behalf of the mutual fund. Unless the custodian certifies and confirms that the gold submitted by the AP matches their standards, the AMCs do not issue creation units. Moreover, the gold held with the custodian is fully insured and is not used for lending. The units are allotted in such a way that the value of each unit corresponds to one gram of gold. This means that if you invest Rs 10,000, when the price of 10 gm of gold is Rs 9,650, you will be allotted 10.20 units (Rs 10,000 - 1.5 per cent entry load / 965).

All subsequent transactions are facilitated by the APs and should be routed through the National Stock Exchange (NSE). The APs provide continuous two-way quotes on which you can either buy or sell the GETF units. You need to maintain a demat account and a broking account. Unlike APs, investors like you do not get any physical gold on sale of units. Like other mutual fund products, GETFs publish their NAV on a periodic basis and this would be linked to the prevailing gold price. Under the present regulations, GETFs in India track London gold prices expressed in US dollars, and represent `standard' gold of 99.5 per cent purity, called 24 carat gold in general parlance.
GETFs – one up on other forms of Gold investment
Since GETFs are traded on the stock exchange, they are liquid. As they are held as electronic entry in your demat account, they offer convenience and you do not have to worry about purity, storage or safety. You can also borrow from a bank against GETF as it is legitimate collateral. In contrast, gold jewellery, bars and coins are repurchased at a huge discount with purity, storage and safety being major issues of concern.

Gold ETFs allow you to invest in gold even if you have a small investible surplus. Instead of waiting until you accumulate enough funds to buy a 50 gm gold bar, you can make an investments in gold ETFs with an outlay of just Rs 10,000, to start with. You can also gradually build your exposures by buying additional units as and when you can afford them and reap the benefits of rupee cost averaging.

Since GETFs are being sold as non-equity (there is no buying/selling of shares) schemes, there is dividend distribution tax (DDT). However, there is no wealth tax (not in possession of gold in physical form) or securities transaction tax (STT). GETFs held for one year are eligible for long term capital gains tax (20% as opposed to 30% for short term capital gains tax) unlike physical gold, where the threshold is three years.
All that glitters is not Gold!
On the returns front, while gold ETFs can add lustre over smaller periods, the returns they generate in the long term are not very encouraging. Entry loads and fund management costs further reduce returns.
If the ETF units are not actively traded in the stock market, you may not be in a position to exit your holdings at the time or price of your choice.
Being low cost products with limited marketing budget, AMCs have to do the awareness effort.

However, these risks appear unlikely to play out in practice. Competition between different ETF products may ensure that these products generate returns that are pretty close to those generated by physical gold. The problems associated with liquidity may be sorted out if the idea of Gold ETFs really catches on with investors. In the past 10 years, gold has returned around 7% CAGR (compounded annual growth rate), which is comparable with other fixed-income instruments. This alone should entice investors towards this asset class.
Invest in GETFs if
  • Gold is just one more asset
  • You are comfortable with returns that are just better than inflation.
  • You are an investor and not looking at trading to take advantage of short term price movements.
  • You want capital gains and wealth tax benefits.
  • Easy entry and exit are important.
Don’t invest if
  • You need the comfort of physical gold
  • You are looking at an asset class that earns a high rate of return
  • You are an investor and looking at trading to take advantage of short term price movements.
Granted, electronic gold is no substitute for physical gold in one’s possession as the core foundation of a prudent portfolio, GETF is a great starting point for gold lovers. Gold should ideally not account for more than 5 per cent of your long-term investment portfolio. The reason is that in the long term it is likely that other investment avenues like equity and property are more beckoning. Gold is a store of value and a hedge in turbulent times, not a wealth-creation investment vehicle. Given the geo-political risk globally, gold is a very good all-seasons asset. The purchasing power of gold remains constant irrespective of the situation. Gold is the only perfect destination on earth for capital to avoid inflation. If you are looking to give your portfolio a defensive tilt, gold is a good option and gold funds the best way to get that exposure. Knowing Indians and their love for gold, GETFs could be a huge success story for the fund houses. A mutual MIDAS TOUCH!