How to choose a gold mutual fund?
26 Dec 2021 - Contact Sayan Sircar
6 mins read
This article will help investors know what to look for when choosing a gold mutual fund to take exposure to gold as a part of their portfolio.
Table of Contents
Introduction
Investors who choose to invest in gold for their portfolio have an option of looking at Gold Mutual Funds to invest, as per the conclusion of our article on buying gold: What is the best way to invest in gold?. There are currently 21 mutual funds and exchange-traded funds (ETF) that invest in gold in India. This post shows you what to check to consider to choose one to invest in.
Disclaimer: This post does not say that you should invest in gold mutual funds, but if you want to, this is how to proceed in selecting a fund.
A gold fund is an important consituent of the permanent portfolio. Read more here: Should Indian investors invest in the permanent portfolio?
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What is a gold MF/ETF?
A gold MF/ETF has the same concept as an equity fund. But, instead of investing in stocks, it invests in gold bullion kept in a vault overseen by a custodian of assets. This product, unlike digital gold, is SEBI regulated. In India, gold for investing has been historically launched as ETF first and then as a fund of fund (FoF) that invests in the ETF.
Gold mutual funds in India invest in the underlying ETF of the same AMC. There are 11 ETFs and 10 MFs currently that invest in Gold.
Factors for choosing a gold fund
A gold fund is a passive fund and should be chosen based on
- Expense ratio (TER): lower is better
- Return vs gold price: there should not be excessive deviations from the price of gold
- Fund size or AuM: since the underlying is the same in all funds, fund size does not matter that much. However, too small AuM will indicate a lack of liquidity in the ETF due to less trading. Smaller inflows will lead to difficulty in creating new ETF units at NAV for the FoF to invest.
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ETF or MF
ETFs have a few advantages over mutual funds:
- immediate access since it is traded during the day in stock exchanges vs MF, which are purchased at EOD NAV
- low expense ratio vs two-level TER for MF (own plus ETF)
- better tracking of gold price
However, MFs have a few advantages over ETF
- SIP possible for any amount vs integer number of shares to be bought by actively placing an order
- switches with other mutual funds from the same AMC
- liquidity issues and price/NAV variation
The last point requires a bit of elaboration. Since an ETF trades like a stock, the price which an investor can buy/sell will depend on the demand and supply of the units. As the table shows below, some ETFs have extremely poor liquidity demonstrated by share of daily trading volume:
| ETF | Value share % |
|---|---|
| Invesco | 0.1% |
| UTI | 2.1% |
| Nippon | 33.7% |
| SBI | 15.6% |
| Kotak | 17.4% |
| IDBI | 0.3% |
| ICICI Prudential | 4.7% |
| Quantum | 0.8% |
| Axis | 15.6% |
| HDFC | 9.3% |
| Aditya Birla | 0.3% |
Source: NSE, 21-Dec-2021
Another issue with ETFs is the price variation at which the ETF trades and the NAV, which depends on the underlying asset’s value, which is gold. This phenomenon causes a discrepancy between the expected return as per NAV and the price at which the trade happens since the price/NAV variation is unpredictable. Mutual funds do not have this issue since they can buy and sell directly with the AMC at NAV. However, if inflows are low, AMCs may be forced to purchase ETF units at market price, which will cause deviations from NAV.
To trade in ETFs, you must carefully place the order near the ETF’s indicative NAV (iNAV) to avoid buying or selling at too wide a gap. iNAV is declared in near-realtime on the AMC website throughout the trading session. The price/NAV variation is visible even over large periods, as shown by this chart from Valueresearchonline for SBI Gold ETF. This hassle is avoided by sticking to high AuM gold mutual funds.
Ranking table
We have prepared a simple ranking system for gold funds based on AuM, expenses, and price out-performance vs domestic gold price using data from Valueresearchonline.
| Category | Weight |
|---|---|
| TER | 1 |
| Weekly returns | 1 |
| Monthly returns | 1 |
| Quarterly returns | 1 |
| AuM | 1 |
| Liquidity of ETF | 1 |
| vs Gold Price 1W | 1/52 |
| vs Gold Price 1M | 1/12 |
| vs Gold Price 3M | 1/4 |
| vs Gold Price 6M | 0.5 |
| vs Gold Price 1Y | 1 |
| vs Gold Price 3Y | 3 |
| vs Gold Price 5Y | 5 |
The result is as follows:
The table should not be interpreted as a recommendation to invest in the top-ranked funds. Instead, it shows one way to select a gold fund based on parameters that materially impact the performance (like expense ratio) and how closely the fund tracks the price of gold. Investors should perform their own due diligence before investing.
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