Posted On Thursday, Jan 07, 2010
"Can somebody explain that, if all gold ETF`s track the same gold price, how is it that returns of the Quantum Gold ETF are at the bottom of the heap? Is it because the expenses are abnormally high?" asked an email.
I couldn’t believe this query from a reader and proceeded to check the actual returns based on data supplied by the Association of Mutual Funds in India (AMFI) (see Table 1).
Table 1: Setting the record straight: Quantum is not at the "bottom of the heap"
1 Year returns
Returns since 1st NAV of Quantum, February 27, 2008 (annualized)
|Domestic Prices of Gold|
|Quantum Gold ETF||13.70%||15.08%|
Benchmark Gold Bees
UTI Gold ETF
Kotak Gold ETF
Reliance Gold ETF
I have not chosen a specific time frame that is favorable to us.
I have simply selected the time horizon from the day Quantum declared its first NAV - February 27, 2008.
Table 1 shows that all gold ETFs have done well because the price of gold has increased - with the usual jumping around - during this entire period.
As regards the expense ratios, there’s no real difference there, all of the Funds (including us) seem to charge 1% p.a.
But investors would also want to find out the reason for the difference between the returns of these Funds.
So, let us take a look at the returns for the month of August 2009 for 2 specific funds:
How is it possible for a fund to return more than the underlying asset it holds?
In fact, the returns should be a little less than the underlying return from owning gold because there are real costs of running a gold fund. The Fund has to pay salaries, custody costs, and accounting and audit costs to name a few. All this has to be deducted from the NAV
So, if a fund is buying underlying gold, how can its return be higher than the return rate of gold itself?
Well, it is possible that some funds may not be able to invest in gold the very day that they get your money ("new cash" to buy gold). Now, if the price of gold falls the next day, they will be able to get more kilos of gold for the same rupee amount. But, if the price of gold increases in the future, they’ll get the "kicker" of the extra kilo of physical gold that they would have been able to buy.
But let’s say that the Fund does manage to go ahead and buy the gold the same day it gets the "new cash". Now if the price of gold declines the next day, then the Fund will suffer a loss. On top of this loss will be the operational costs of running the Fund, so the total losses will be more than the loss from owning just the physical gold.
However, over time, this effect of "timing" the purchase of gold from the "new cash" will be minimal. Some days the Fund will gain, some days the Fund will lose. Thus, the random movement of the price of gold should not hurt the returns of the Fund.
The above discussed case example can happen with the funds either during their New Fund Offering (NFO) stage or if they accept cash on an ongoing basis, which would require them to deploy the cash collected.
However, most of the gold ETFs in India follow an "in kind" structure to get new inflows. An "in kind" structure means that gold ETF units are created / redeemed only for physical gold thereby limiting tracking error. (It is vital for you as an investor to read the Offer Documents of each of the funds to understand exact details.)
Another point to note, is that every time gold is purchased, there is a Value Added Tax (VAT) that is paid. Over a period of time, the gold ETF gets a refund of the VAT it paid during the earlier years. This lowers the cost of investments (because cash has come back into the ETF’s coffers), adds to the NAV of the gold ETF, and increases the reported returns due to a spike in the NAV of the Fund. Of course, over time this near-term comparative performance is neutralised as other Funds get the same benefit..
Fund houses may also have a different treatment of their C.I.F premium. This refers to the cost of bringing gold into India and the cost to the intermediaries that import gold. Higher the CIF premium, higher would be the landed price of gold resulting in a higher valuation.
This "cost, insurance, freight" premium varies from bank to bank and fluctuates on the basis of demand / supply of gold in the Indian markets; the cost of funds; and each fund manager’s assessment of the "correct" C.I.F. premium for valuing the existing gold stock.
A standard accounting policy adopted across Fund houses on the treatment of VAT and the C.I.F. value of gold will go a long way in providing investors with better gold ETF return comparisons.
Every "pure" gold ETF should, in a simple analysis, give you the rate of return of the underlying gold price minus what it costs to operate such a gold ETF.
Over the long run, it is impossible for a gold ETF to earn you more than what the rate of return from an investment in the underlying gold can be.
We do not time the market nor take a call on gold prices. This is also reflected in our tracking error which stands at 0.009% (absolute) since our Inception. The tracking error is a measure of how closely a portfolio follows the index to which it is benchmarked. This measure reports the difference between the return you received and that of the benchmark you were trying to imitate.
So, while investing in gold ETFs, it is important to understand:
What is the percentage of the fund’s investments in gold?
You need to check the Fund’s factsheet to figure out what proportion of the fund’s assets are in gold. The closer the fund’s investment in gold is to 100%, the better it will track gold prices.
Does the Fund take directional calls on gold price movement or do they use a passive managing approach?
What are the accounting and valuation policies towards (for example) VAT and CIF?
What is the overall expense ratio of the Fund?
the lower the expense ratio; lower will be the deviation from the price of gold.
At Quantum Mutual Fund we manage the Quantum Gold ETF as a passively managed fund which aims to track the price of gold by investing in physical gold. We endeavor to stay close to 100% invested in physical gold at all times. We do not take any directional calls on where the price of gold is likely to be.
So, Dear Reader, Quantum Gold ETF is not "at the bottom of the heap" but better standardised policies would be good for you.
Invest in gold in an efficient manner - Invest in Quantum Gold ETF
The views expressed in this article are the personal views of the Fund Manager of Quantum Gold Fund. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. This information is meant for general reading purpose only and is not meant to serve as a professional guide/investment advice for the readers. This article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Readers are advised to seek independent professional advice and arrive at an informed investment decision before making any investments. Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors.
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