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FAQs on Exchange Traded Funds

    IndianMoney.com Research Team | Friday, May 01,2009, 06:46 PM
 

1. What is an Exchange Traded Fund (ETF)?


Exchange Traded Funds are essentially open ended funds that are listed and traded on exchanges like stocks. They enable investors to gain broad exposure to indices or defined underlying asset with relative ease, on a real-time basis, and at a lower cost than many other forms of investing.

2. Why should I invest in Gold?


  • An Excellent Diversification for your Portfolio
  • Global Asset Class
  • Hedge against Inflation
  • Low Volatility as compared to Equities
  • Store of value

3. What are the benefits of investment in gold ETF?


When you go to the bank or a jeweler to buy the gold, you have to pay a certain premium. As a result, returns contract. A premium of 20% if charged on small coins of 5 gram each and 5-10% on the gold coins weighing more than 5 grams. When you go to jewelers to sell gold, it is taken back on a discounted price. Apart from his, you have to keep your gold in the lockers and pay for locker facility.

4. How is tax calculated on gold ETF?


There are more tax benefits on the gold ETF as compared to physical gold. Capital gains tax calculations are similar to the tax calculations on the bond funds. When you invest in physical gold, long-term capital gains tax is levied only after three years. In case of the gold ETF, which is a kind of mutual fund, long-term capital gains tax is levied one year after purchase. You will get the benefit of indexation. But when you keep the physical gold, you have to pay wealth tax, which doesn't apply to mutual funds. If your wealth crosses Rs 15 lakh (Rs 1.5 billion) in a year, you have to pay 1% as a wealth tax. Besides this, you save on STT (Security Transaction Tax), which you have to pay on other securities in the secondary market.

5. What are the benefits of investing in gold?


Worldwide, the government and individuals keep the gold. Many governments move forward and would want to keep their forex reserves in the gold. Developed countries such as USA and UK always try to keep 60-70% of their reserves in gold. But some of the developing countries like India, Brazil, Russia, have only 1-2% of their reserves in gold. As US dollar is becoming volatile, its deficit in US is growing and US dollar, according to economists, will grow very weak.

Many of the developing countries are now thinking of keeping more forex reserves in the gold in order to prevent impact on their reserves due to volatility. So, governments will buy more gold in the future. Suppose there's a war or a big currency crisis, like the one in 1997-98 when currencies of strong economies like Singapore, Malaysia depreciated by 30-40%. While it is certain that the currency gets depleted in case of a currency crisis, stock market and bond markets also get depleted. Gold is an investment option, which can position against the tide.

6. What are gold ETFs?


Also known as paper gold, Gold ETFs is mutual fund schemes that invest in standard gold bullion (99.5% purity). They are special types of exchange traded funds (ETFs) which tracks the prices of gold (i.e. whose value is based on price of gold) and are convenient and inexpensive alternative to owning physical gold.

7. What is the origin of Gold ETFs?


The World’s first Gold ETF (exchange-traded fund) was launched in Australia in March 2003. In United States, first Gold ETF was launched in 2004. But the idea was originated in India way back in 2002 when Benchmark filed a proposal with SEBI in May 2002. However, it could not be launched at that time due to not getting the required regulatory approval. Finally, in Feb’2007 Benchmark launched India’s first gold ETF.

8. How do Gold ETFs differ from physical gold?


Unlike physical gold, Gold ETFs are held in demat / electronic form and can be traded on a stock exchange just like buying and selling stocks.

9. How are Gold ETFs better than physical gold?


Gold ETFs definitely score over physical gold, because they eliminate the hassles and drawbacks of physical gold (e.g. impurity risk), are more tax-efficient and allow you to invest in small amounts.

10. How are Gold ETFs better than Gold Funds?


Gold ETFs are better than Gold Funds because in comparison to Gold funds, Gold ETFs are less volatile. While gold ETFs invest in physical gold, Gold Funds invest in equities of gold mining companies; and gold stocks are more leveraged to the gold prices than the gold itself.

11. What are the returns of Gold ETFs?


Returns of all Gold ETFs schemes are almost same and more or less similar to physical gold because they are passively managed fund and closely track the performance and yield of gold in the spot market. Put simply, they just hold physical gold on behalf of investors and no active fund management (to take advantage of price fluctuation in gold) is involved.

12. How are Gold ETFs taxed under Income Tax Act, 1961?


Gold ETFs schemes are treated like non-equity mutual funds for the purpose of taxation. So, the gains attract short term capital gains (STCG) tax if held for less than one year and long term capital gains (LTCG) tax if the period of holding is more than a year. As far as dividend distribution tax (DDT) is concerned, the question doesn’t arise as none of the Gold ETFs in India have declared any dividend so far.

13. Which are the currently available Gold ETFs in India?


As of now, there are five gold ETFs available in India; one each by Reliance, UTI, Benchmark, Quantum and Kotak fund house. The NSE symbols of Gold ETFs are (GOLDBEES, GOLDSHARE, KOTAKGOLD, RELGOLD, and QGOLDHALF)
  • Gold Benchmark Exchange Traded Fund --> GOLDBEES
  • UTI Gold Exchange Traded Fund --> GOLDSHARE
  • Kotak Gold Exchange Traded Fund --> KOTAKGOLD
  • Reliance Gold Exchange Traded Fund --> RELGOLD
  • Quantum Gold Exchange Traded Fund --> QGOLDHALF

14. How to invest in Gold ETFs?


Gold ETFs are listed and traded on national stock exchange (NSE). They are held in demat form just like the stocks. You require a DMAT account to invest in them (and for that you also require a PAN). Besides, you also require a trading account with a broker (who is a member of NSE). Typically, each unit in Gold ETF represents one-tenth of an ounce of gold. In other words, small sum is required to gain exposure to the gold price. For example, while in case of Gold Benchmark Exchange Traded Fund (GOLDBEES), each unit corresponds to one gram of gold, Quantum Gold Exchange Traded Fund (QGOLDHALF) is available in 0.5 grams of gold.

15. What is an Exchange Traded Fund or ETF?


Exchange Traded Funds or ETFs are investment schemes whose units are listed after NFO on stock exchanges and traded like equity shares. An ETF would have some underlying security or group of securities like an index, sector stocks or commodities, like gold. These underlying securities determine the ETF’s value.

16. Why should one invest in the Quantum Gold Fund? With so many gold ETFs schemes launched in the market, what is different about the Quantum Gold Fund?


The Quantum Gold Fund seeks to offer investors an innovative, cost-efficient and secure way to invest in gold. Through the lower cost of operations and the availability of units having smaller denominations, the Quantum Gold Fund would provide investors an excellent means of asset allocation. Each unit of the Quantum Gold Fund will approximately be equal to ½ gram of pure gold (0.995). Thus, an investor can buy gold in units of ½ gram, one of the lowest thresholds for investing in gold. This could be lower than Rs. 600/ per unit, based on the domestic price of Gold as on January 9, 2008.

17. What are the applicable loads in the QGF?


As mentioned earlier, The Quantum Gold Fund would also be the first Gold ETF in the country without any entry loads, during the NFO.

During New Fund Offer Period :

Investor Category

Entry Load

Exit Load

Authorized Participants

Nil

Nil

Eligible Investors

Nil

0.50%

Retail Investors

Nil

Not Applicable*


Retail Investors can exit the scheme only through Secondary Market. (B) Ongoing Basis:
On an ongoing basis exit is provided by the Fund only to Large or eligible investors. Large/Eligible investors are those holding 2,000 units or more. Retail investors (i.e those holding less than 2,000 units) who wish to sell their units exit is only through sale in the exchange (the NSE.) The load structure is however, subject to change from time to time and such changes shall be implemented prospectively.

18. What will be the purity of the gold bars?


All gold bullion held by the fund will be 1kg bars of 0.995 purity sourced from LBMA (London Bullion Market Association) approved refiners.

19. How do you compare QGF units with other forms of investment in Gold?


By investing in QGF units, investors can get exposure to gold without the hassles of physical delivery of gold. The QGF will closely track, before expenses, the yield of its underlying asset - 0.995 pure gold. If gold were purchased in the physical market; either from a retail jeweler or a bank, additional premiums or makingcharges would be added. This could straight away lead to a loss of about 5 to 20% of the value of the gold. By investing in ETFs, these additional costs can be avoided.

The hassles of holding physical gold are also avoided. The investor has the advantages of owning gold, without incurring additional expenses and losses like making charges (for gold jewellery), and bank vault charges (for keeping coins or bars or jewellery). Buying and selling is also very easy. There is no need to physically carry the gold for a transaction. Like any other traded security, one can buy and sell ETFs though your broker on the stock exchanges. It would be as convenient as calling your broker on the phone or placing an order online.

Parameter

Jeweler

Bank

QGF

Purchase and Sale

In physical form

In physical form

In dematerialized form

Price advantage

No - sells at higher premium

No - sells at higher premium

Yes -likely to be least premium

Price standardization

No - varies from jeweler to jeweler

No- varies from bank to bank

Yes - linked to international gold prices

Making charges

Incurred

Incurred

Not incurred

Risk of impurity

May exist unlikely

but possible

Not incurred

Storage requirements

Locker or safe

Locker or safe

Held in demat form

Security Responsibility

Owner / Investor

Owner / Investor

Fund House

Resale

At loss after deduction of making charges

Banks do not buy back

At listed exchange at transparent prices

Convenience in holding and transacting

Low - due to physical movement and transfer

Low - due to physical movement and transfer

High - due to demat form

Tax advantages

Low

Low

High

20. What is the expense ratio of the QGF?


The Quantum Gold Fund’s total expense ratio is estimated to be 1.25% per annum.

21. What is the tax treatment for the investments in Gold ETFs like the QGF? Do I have to pay any wealth tax or STT (Securities Transaction Tax) on gold ETFs?


Gold ETFs have several tax advantages over holding physical gold.

Parameter

Jeweler

Bank

QGF

Wealth Tax

Applicable

Applicable

Not Applicable

Short Term Capital Gains Tax

Applicable before 3 years

Applicable before 3 Years

Applicable before 1 year

Long Term Capital Gains Tax

Applicable after 3 years

Applicable after 3 Years

Applicable after 1 year


For Tax purposes, QGF Units are treated as non equity mutual fund units. Therefore, the Long Term Capital Gains (LTCG) tax is 20 per cent (plus surcharge and cess, if applicable) with indexation or 10 per cent (plus surcharge and cess, if applicable) without indexation, whichever is lower.

To qualify for LTCG, Gold ETFs have to be held for at least 1 year. In the case of physical gold, LTCG can be availed only after holding for at least 3 years.

Short Term Capital Gains (STCG - holding period of less than 1 year) tax in case of Gold ETF units will be added to the investor’s income and taxed at the normal income tax rates applicable.

Gold ETFs do not attract wealth tax or Securities Transaction Tax (STT).

IndianMoney.com Research Team

The research team at IndianMoney.com comprises of certified and experienced professionals who share the company's vision to make every Indian financially literate by equipping every Indian with right and unbiased advice. IndianMoney.com research team provides newsletters, articles, videos and FAQs on various financial products and concepts only to help you make wise financial decisions.

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