Weekly Musings – NFO Pick (DSP Gold ETF – Fund of Funds)

6 Nov 2023 , 09:20 AM

WHY A GOLD ETF – FUND OF FUNDS

The Gold ETF is an exchange traded fund (ETF) that has its underlying as gold and issues proportionate units to investors. The NFO of the DSP Gold ETF Fund of Funds (FOF) is a unique way of using the FOF route to invest in the DSP Gold ETF. So, the DSP ETF would be the core subject of investment and the FOF would act as a feeder fund to invest in the DSP Gold ETF. What is the value addition here and can investors not directly invest in the Gold ETF? How would the fund of funds (FOF) add value to the investor?

There is a subtle difference to be understood here. The ETF is an exchanged traded product and the buying and selling of ETFs happens at NAV linked on the stock exchange. That means, buying gold ETFs would need you to have a trading to execute the transaction and having a demat account to hold the gold ETFs. In India, the demand for gold is much wider than the demand for equities and hence an ETF may limit the customer base. Now, with the Gold ETF FOF that DSP has launched, even people without a demat account and trading account can invest in the Gold ETF FOF and participate in gold as an asset class, without the hassles of physical holding, maintenance, and transfers.

WHY CONSIDER INVESTING IN DSP GOLD ETF FOF

There are several reasons why investors should be looking at gold as an asset class. Here are some compelling reasons to consider the DSP Gold ETF FOF as an investment option.

• Gold Fund ETF FOF offers the benefit of diversification. Gold has a special advantage in diversifying the risk of your portfolio since gold as an asset class has low correlation with other asset classes like equity and bonds. That means, the low corelation will help hedge your overall portfolio risk against the vagaries of market cycles.

   

• They say that gold as an asset class has never disappointed as an asset class. Let us look at the proof of the pudding. If you look at gold as an asset class over a period of the last 20 years, then the average compounded annual growth rate (CAGR) is about 12%, which is a very good return on a safe and secure type of asset class.

   

• One of the big advantages of using the ETF route to buy gold is that you can invest as low as Rs100 in a gold ETF. That means, there are not entry barriers when it comes to how much you can or should invest. The same applies to the DSP Gold ETF Fund of Fund (FOF). Also, as stated earlier, there is no need for demat account or trading, unlike in the case of a gold ETF. The FOF can be bought even without a trading and demat account.

   

• One question that people often ask about physical gold is about the purity. It is not everybody’s cup of tea to be able to assess the purity and quality of gold. In a gold ETF FOF, you don’t worry about that. In this case, you can be rest assured that each unit of DSP Gold ETF FOF invests in units of DSP Gold ETF which is backed by physical Gold of guaranteed high purity. Typically, the backed gold is of 24 carat variety.

   

• Gold is considered to be a safe haven asset. That means; in times of economic crisis or in times of geopolitical uncertainty, gold gives the best returns. For instance, gold outperformed in periods like the global financial crisis of 2008, COVID crisis of 2020 etc. In such situations, an equity or bond portfolio would have seen deep cuts, but gold gains would have largely neutralized the losses.

So, this is how it works. The DSP Gold ETF FOF will invest in the DSP Gold ETF, which in turn would hold physical gold of equivalent quantity of the said quality with a custodian bank. In short, your assets are fully secured in terms of asset quality, although price risk still remains. One thing you need to remember is that gold is not like equities, where long term holding can automatically improve returns. When it comes to gold, it is essential to understand gold price cycles and invest accordingly.

DOES GOLD REALLY OUTPERFORM EQUITIES IN TOUGH TIMES

If you look at the long term chart of the US dollar and gold over the last 30 years, you will find that gold has done well, whenever the dollar has not done too well. That is partially because gold is denominated in dollars, but also because gold is seen as a safe haven assets. But is that really the case and does gold really outshine other asset classes in tough times. Let us look at five key data points in the last 25 years to get an idea.

• Let us go back to the bursting of the tech bubble in the US and the subsequent implosion of tech stocks in India post year 2,000. If you look at the period between March 2000 and March 2003; Equities were down -14% during this period. In the same period, gold had rallied by 8%.

   

• Let us turn to the global financial crisis (GFC), which started in early 2008 and continued well into 2009. If you look at the period between January 2008 and March 2009; Equities were down -52% during this period. In the same period, gold had rallied by 37%.

   

• Does gold also outperform equities in times of flat markets or when equities are virtually going nowhere. Let us consider the period between December 2010 and December 2012; a period when the Nifty did nothing. During this period, the Nifty was down marginally by -2% while gold had rallied by 20%.

   

• Let us now turn to something more recent that is still fresh in our memories i.e., the COVID crisis, which took the world by storm post 2019. If you look at the period between October 2019 and March 2020; Equities were down -28% during this period. In the same period, gold had rallied by 13%.

   

• Finally, let us come to the Russia Ukraine war, that started off in late 2021 and is still going on as of date. If you look at the period between October 2021 and March 2023; Equities were down -4% during this period. In the same period, gold had rallied by 15%.

So, what is the moral of the story. Clearly, the above instances illustrate the importance of gold in the portfolio. It not only protects the portfolio but also generates alpha in tough times. That is where the DSP Gold ETF FOF would fit in for investors.

WHY GOLD COULD AGAIN BE IN A SWEET SPOT TODAY

As we stated before, when buying gold, the same long term approach like equities cannot be adopted. It is essential to understand cycles and invest accordingly. Hence sweet spots matter. Here is why gold could be in a sweet spot now.

• Today, apart from the traditional demand from jewellers and ETFs, the demand from central banks has been rising. Two of the central banks of India and China have been buying gold aggressively. Many countries are also using gold to diversify their reserves away from the dollar. In 2022, the central bank demand for gold was around 1,200 tonnes compared to an average of around 600 tonnes per year in the last 10 years.

   

• In the case of gold, it is not just about demand, but even supply has struggled to keep pace. For instance, between 2006 and 2017, the gold supply grew from 2,500 tonnes to 3,600 tonnes. However, over the last 6 years, the supply has stagnated at the same level. This mismatch is likely to be price positive for gold.

   

• Gold returns have been flat for too long . For example, in India, the gold prices have been virtually flat in the last 3 years . if you look at the global gold market, it is worse. Gold, as an asset class, gave 17% CAGR returns for the 12 year period from year 2000 to year 2012. However, the price of gold today is exactly where it was in 2012, showing virtually zero returns in the last 12 years. The time is ripe for a gold rally.

In these circumstances, a strategy of adding gold to your existing portfolio can not only hedge risk, but also offer entry into gold as an asset class when it is in a sweet spot.

HOW DSP GOLD ETF FOF COMPARES WITH OTHER GOLD OPTIONS

Let us take a quick comparison of gold ETF FOF with other similar gold assets like gold ETF, sovereign gold bonds and physical gold.

• The DSP Gold ETF FOF would rank on purity and on safety. Gold ETF FOFs are backed by physical gold, so every unit of gold held by an investors has the backing of gold. Of course, the price risk is still there, but default risk and asset integrity risks are not there.

   

• The DSP Gold ETF FOF has some unique advantages on a comparative basis. Unlike the gold ETF, the DSP Gold ETF FOF does not require that investors should have trading accounts and demat accounts. Also, unlike the sovereign gold bonds, the DSP Gold ETF FOF is highly liquid and exit is hardly a problem. Unlike physical gold, you don’t worry about safety and maintenance or loss of value.

   

• Gold ETFs are denominated in units of gold that are equivalent to grams. Sovereign gold bonds are denominated in grams of gold. However, the DSP Gold ETF FOF is denominated with units of the FOF, like any other mutual funds, making it simpler.

   

• In terms of tax treatment, the taxation on Gold ETF FOF is the same as a Gold ETF. Unlike the SGB, the Gold ETF and the Gold ETF FOF do not have the benefit of capital gains tax exemption if held for more than 8 years.

There are no fixed returns and it depends on the price movement of gold. The bottom line is that gold does well in low interest scenarios as it sharply reduces the opportunity cost of holding gold.

HIGHLIGHTS OF THE DSP GOLD ETF FUND OF FUND (FOF)

Here are some key takeaways that investors should know about the NFO.

• The DSP Gold ETF Fund of Fund (FOF) NFO opens for subscription on November 03, 2023 and closes on November 10, 2023. Anil Ghelani and Dipesh Shah will be the fund managers. It is an open ended fund of fund (FOF) scheme investing in DSP Gold ETF.

   

• The performance will be benchmarked to the domestic price of gold based on the daily London Bullion Market Association (LBMA) gold spot prices.

   

• Being a gold ETF FOF, the objective is to offer gold in an investment form to enable investors to hedge their risks.

   

• Lumpsum purchases in the NFO and SIPs must for a minimum of Rs100 and any amount thereafter. There will be no other restriction.

   

• There will be no exit load in the fund. However, the regular plans will be subjected to expense ratio of 0.5% on regular plans and 0.2% on direct plans.

It must be noted that the DSP Gold ETF FOF would be subject to taxation at your marginal rate of tax applicable.

UNDERSTANDING THE GOLD ETF UNIVERSE IN INDIA

Here is a quick look at the other gold ETF universe in India. 

Scheme Name	Return 1 Year (%) Regular	Return 1 Year (%) Benchmark	Return 3 Year (%) Regular	Return 3 Year (%) Benchmark	Return 5 Year (%) Regular	Return 5 Year (%) Benchmark
Kotak Gold ETF	19.22	20.33	5.56	6.27	12.95	13.77
Nippon India ETF Gold BEES	20.59	20.25	5.03	6.12	12.74	13.81
Quantum Gold Fund	21.14	20.33	5.16	6.27	12.74	13.77
Aditya Birla Sun Life Gold ETF	21.24	20.33	5.34	6.27	13.00	13.77
ICICI Prudential Gold ETF	21.29	20.33	5.36	6.27	12.83	13.77
HDFC Gold ETF	21.32	20.33	5.32	6.27	12.79	13.77
SBI Gold ETF	21.76	20.33	5.47	6.27	13.04	13.77
Invesco India Gold ETF	21.96	20.33	5.57	6.27	13.16	13.77
UTI Gold ETF	22.22	20.33	5.20	6.27	12.78	13.77
LIC MF Gold ETF	22.59	20.33	5.88	6.27	13.23	13.77

Data Source: AMFI

It is clear that at Rs23,000 crore, the gold ETF AUM is still small in India. But the message is that gold as an asset class is not about long term or medium term holding. It is about getting the cycle timing right.