'Underlying gold in ETFs are audited and carry insurance protection'

Expanding investor awareness will continue to propel the transition from physical gold into ETFs more sharply in the days ahead says Ms Lakshmi Iyer, Head of Products & Fixed Income – Kotak Mutual Fund. On the occasion of Dhanteras, here's an interview with Ms Iyer on how gold ETFs are created and where the underlying asset is stored.

What kind of growth in volumes and AUM have gold ETFs in India witnessed in the last three years?

The average volume growth in this segment, between October 2008 and October 2011, has been around 243 per cent (absolute) or around 51 per cent compounded annually and stood at above 190,000 units per day. In approximately the same period, the assets under management growth in the gold ETF segment expanded by around 905 per cent in absolute terms, or 150 per cent year-on-year, and now stands at around Rs 8,173 crore.

Is equity market volatility prompting an increase in gold ETF volume?

The equity market volatility may have prompted many an investor to transfer a portion of his/her allocation into gold to protect its value. But more so, there has been a shift in the manner in which traditional gold investors have been taking exposure (physical) to this asset class. Also, worldwide erosion in the value of the dominant currencies, the global recessionary fears, and the geopolitical uncertainty; all of these factors may have prompted the investors to increase their exposure to gold.

Given that gold has no fundamantals unlike most other asset classes, can the unusual run in the last three years be merely attributed to demand from ETFs?

The demand for gold ETFs in the past few years must not be seen in isolation. It has largely been the transition of an already existing investor segment from the traditional medium, to a more sophisticated and convenient form. However, by itself, the demand in gold has expanded for a variety of reasons political and economic, and that demand has also reflected in the growth of gold ETFs.

Do you see a clear shift in people moving from buying physical gold to purchasing ETFs?

The shift is indeed occurring, but it is not that noticeable in the vast Indian demand, which is still largely being met by physical transaction. Having said that, the expanding investor awareness will continue to propel this transition into ETFs more sharply in the days ahead.

Can you explain how Gold ETFs get created and what are the components of the expense ratio that are charged on investors' holding?

ETF unit creation occurs in largely two circumstances: “funds” transfer and/or Portfolio deposit. In the former case, the AMC receives the money from the Authorised Participant (AP). In lieu of this money, the AMC purchases the physical gold of the commensurate value from the gold supplier, and deposits it with the custodian. Simultaneously, the AMC creates the Gold ETF units of the approximate corresponding value and deposits the same in their account. In the case of “portfolio deposit”, the AP transfers the physical gold directly into the AMC’s account, in lieu of which, the AMC creates the units and transfers it to them. Investors wishing to purchase in multiples of 1,000 units can approach the AMC directly for creation of units (applicable with Kotak AMC). The entire expenses of the Gold ETF are managed within the 1 per cent (per annum) of the invested corpus.

Many investors wish to know where and in what form is the underlying gold (of gold ETFs) kept and how safe it is.

There is a third-party custodian for the physical gold that backs the Kotak Gold ETF. The custodian is appointed by the Trustees and is pre-registered with SEBI. The location of the said assets is in Mumbai and is maintained by the custodian’s vault agent – who ensures the necessary security for the assets. The asset is duly audited from time to time and also carries an insurance protection.

Can there arise a risk of an investor not being able to sell units in the market?

That would mean that there might be no retail or institutional buyer for gold, which seems an unlikely event. Were the liquidity in the Gold ETFs to remain tight, the underlying value in gold would begin to emerge, this in itself would prompt buyers to seek and capitalise on potential buying opportunities.