- With
gold ETFs , you can enter or exit at any point in time taking timely advantage of the price movements. Gold ETFs mirror the current market value ofphysical gold , enabling investors to trade them on the exchange throughout market hours.- Investors who do not have a demat account choose to invest in Gold ETFs through gold fund of funds.
Both Gold ETFs as well as
A gold ETF is a passive investment instrument that invests in physical gold of very high purity and aims to mimic the returns of domestic physical gold. SGBs, on the other hand, are government securities denominated in grams of gold.
SGBs surpass gold ETFs in returns due to their 2.5% annual interest and tax benefits on capital gains upon maturity. Yet, investors persist in Gold ETFs for various reasons.
Some of those reasons are.
Gold backing: Unlike Gold ETFs, SGB’s are not backed by physical gold. Many investors prefer the security of gold backing instead of a government guarantee. That is justified because gold’s value is derived from the fact that unlike equities and debt, it is no one's liability.
Flexibility to enter and exit: While investing in a SGB with the intention of holding the bond till its maturity and benefitting from the capital gains tax advantage, the investor lands up taking a bet that gold prices will be up 8 years later at time of redemption, which may or may not be the case.
“For instance, gold prices may peak 4 years into the investor’s SGB holding period, but the investor will be unable to sell it and book profits. By the time the maturity arrives, prices may have moved down again," says Ghazal Jain, fund manager, alternative investments, Quantum AMC. .
Thus, you may have bought SGBs to capitalise on the capital gains tax advantage but that will be helpful only if there are gains to be taxed.
Although gold has historically given better returns over long time periods, there may be cycles where gold doesn’t perform.
For instance, gold bought in 2011 didn’t have much capital gains in the ensuing 8-year period. So was the case for gold bought in the 1980s until the mid-1990s.
This lack of flexibility is not only true for selling, but also relevant in case of buying. When gold falls and becomes attractive, there may not be a SGB tranche available for one to invest. In such cases one may lose out on a lucrative entry point for gold.
This is not the case with gold ETFs, where you can enter or exit at any point in time taking timely advantage of the price movements in gold to either build your exposure or book profits.
Liquidity at fair prices: SGBs have an 8-year tenure with an exit option from 5th year onwards only. Tax benefits are only applicable if the bond is held till maturity, which limits liquidity in secondary markets. Thus, SGBs are usually seen trading at a discount on the exchanges.
“So, if an investor wishes to sell the SGB before the 8-year maturity, he may be forced to sell the bond at a discount in the secondary market which would eat into investor’s returns,” says Jain.
On the contrary, Gold ETFs offer high liquidity. These ETF units mirror the current market value of physical gold, enabling investors to trade them on the exchange throughout market hours at rates closely aligned with the market price. Consequently, Gold ETFs are viewed as a more effective and efficient addition to a portfolio.
Gold ETF Vs Gold fund of fund
Generally, one Gold ETF unit is approximately equal to 0.01 grams of gold.
“The units are listed and traded on stock exchanges, and investors can invest in Gold ETFs using a demat account. Gold ETFs offer the investor the ease and flexibility of stock investments and the simplicity of gold investments,” says Jain.
Investors who do not have a demat account choose to invest in Gold ETFs through gold fund of funds. These mutual funds enable them to opt for a systematic investment plan (SIP) and regularly invest in this strategic asset class without having to worry about timing the market.
“Fund of fund is a mutual fund product which invests in an underlying fund. Any investor who wants to go the demat way can go and buy and sell the ETFs in the secondary market. A mutual fund investor can buy a fund of funds,” says Tapan Patel, fund manager, commodities, Tata AMC.
A fund of funds will incur some management fees of the mutual fund, but that will have a minimal effect.
Things to keep in mind
“One should know the expense ratio of the fund. One should also take note of the tracking error,” says Patel. The tracking error measures how closely an investment matches its benchmark; higher values indicate more divergence from the index, reflecting potential risk.
Experts recommend keeping a 10-15% allocation in the portfolio to ride out the ups and downs of the markets. One is also advised to stagger their investments to lower their average purchasing costs.