Over the past one year, gold has yielded a 37.73% return, while the three-year return stands at 18.72%. Looking at a broader horizon, gold has provided a 14.68% return over five years and 11.12% over ten years.
ETFs allow investors to gain exposure to gold price movements without the burden of storage and security. But a crucial question arises: Is there actual physical gold backing India’s gold ETFs?
Yes, India’s gold ETFs are backed by actual physical gold, ensuring that the value of the ETF units is directly linked to the gold price.
As per the scheme information document (SID), the fund houses managing these ETFs purchase gold bars that meet the purity standards set by the London Bullion Market Association (LBMA). The amount of gold held is regularly audited, and investors can check periodic reports released by the respective fund houses.
According to Niranjan Avasthi, senior vice president and head of product, marketing, and digital at Edelweiss Mutual Fund, the physical gold backing gold ETFs are stored securely in vaults. He mentioned that most asset management companies (AMCs) and large bullion dealers have their own vaults where they store the physical gold. The gold must meet the LBMA good delivery norms, ensuring it is 99.95% pure, which is the global standard for high-quality gold.
Where is this physical gold stored?
The physical gold backing India’s gold ETFs is stored in highly secure vaults managed by custodians in India, according to Securities and Exchange Board of India (Sebi) guidelines.
These custodians are responsible for ensuring the safekeeping and authenticity of the gold assets. Sebi has also laid out specific gold delivery norms that the gold ETFs must adhere to in terms of quality and purity.
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When an investor buys or sells a gold ETF, the physical gold is transferred between different vaults belonging to various market participants, such as AMCs and bullion dealers.
Benefits of investing in gold ETFs
According to the Association of Mutual Funds in India (AMFI), gold ETFs offer several advantages over physical gold investments. Each unit of a gold ETF is backed by physical gold of 99.95% purity, ensuring high-quality holdings. Investors can buy and sell ETF units on the stock exchange, offering better liquidity compared to physical gold.
Gold ETFs do not have issues like making charges or storage costs associated with physical gold. More importantly, Sebi ensures that the gold held in ETFs complies with global and local purity and delivery standards.
Gold ETFs vs. gold fund of funds (FoFs)
While gold ETFs directly invest in physical gold, gold fund of funds (FoFs) provide an alternative for investors who do not have a demat account. These funds invest in gold ETFs rather than holding physical gold themselves.
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Two of the largest gold FoFs in India are HDFC Gold ETF Fund of Fund (AUM: ₹3,060 crore) and SBI Gold Fund (AUM: ₹2,920 crore). Since these FoFs allocate funds into ETFs, the backing of their investments also ultimately comes from physical gold.
Challenges and risks
Despite the assurance of physical gold backing, gold ETFs are not without risks. The tracking error—the difference between the ETF’s returns and actual gold price movements—can affect performance. Additionally, changes in import duties, global gold price volatility, and currency fluctuations impact the valuation of the gold held by these funds.
As per the scheme information document, all physical gold procured must follow the LBMA guidelines as mandated by Sebi. This ensures that gold meets the highest quality and compliance standards. However, risks still exist in handling, storing, and safeguarding physical gold.
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One major risk arises when part or all of the gold held by the fund is lost, stolen, or damaged. Additionally, access to stored gold may be restricted due to natural calamities or human actions such as theft, vandalism, or other unforeseen disruptions. External threats like war, invasion, civil unrest, or military interventions can also pose risks to the safekeeping of gold assets.
To mitigate these risks, the custodian maintains comprehensive insurance coverage to safeguard against any potential losses. The custodian is responsible for covering all costs associated with these insurance policies, ensuring investor protection.
The custodian, acting on behalf of the AMC, must verify the weight, purity, and source of gold according to LBMA guidelines. Any violation of these guidelines would constitute a serious regulatory risk under Sebi’s framework.
Conclusion
For investors looking to gain exposure to gold without dealing with physical storage, gold ETFs offer a viable solution backed by actual gold holdings. As per Sebi regulations, these funds are required to invest primarily in physical gold, providing a level of security and assurance to investors.
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As Niranjan Avasthi summarises, gold ETFs in India are fully backed by high-purity physical gold stored in secure vaults, with the gold quality and delivery process regulated by both global (LBMA) and local (Sebi) standards. This ensures transparency, security, and ease of trading for investors looking to add gold to their portfolio.