By Pooja Meswani, CNBC-TV18

Glittering gold has overshadowed all other asset classes this year and shimmering to glory are the Gold Exchange-Traded Funds (ETFs) that came into the market only last year and mirror gold returns. But it has not yet found many takers as compared to physical gold.

Gold ETFs were first launched in March 2007 and completed a year of phenomenal rally thanks to mounting gold prices. As these funds trade on the underlined price of gold, they have given average returns as high as 24% in the last one year with the precious metal appreciating from 10,000 levels for 10 grams of gold to 13,500 levels this year. As the demand-supply mismatch continues, the prices are expected to rise.

India is one of the largest consumers of gold. Nearly 800 tonne of gold is imported every year. Indians account for 23% of the world’s total annual demand for gold. While conventional investment options like jewellery, gold bars and coins still exist, Gold ETFs are another effective way to invest in the yellow metal. But while demand of gold has risen 15% YoY, gold ETFs have still found few takers even after much fanfare.

Dharmesh Sodah, Director, World Gold Council said, “It’s a new product which is being introduced into the market. A substantial amount of work still needs to be done in terms of getting more awareness. I am sure consumers would see the merits and look at Gold ETFs as a very attractive investment option.”

"There needs to be a remarkable change in the mindset of investors that I can also hold gold in the paper form. And that, we believe will take a couple of years," said Lakshmi Iyer, VP and Head–Product, Kotak Mutual Fund.

Experts say if you are looking at gold as an asset class purely for investment, Gold ETFs prove to be a much more investor friendly option and are expected to address issues of higher prices of physical gold, purity and cost of insurance.

“The advantage of gold ETF firstly is easy buying and selling. Typically, if you want to buy physical gold, you have to go somewhere else. The second advantage is storing. If you buy physical gold, you have to store in your house. Thirdly, you can do transactions on denomination in Gold ETF because here you can buy even one unit. While in physical gold buying1 gram and adding them is painful because you have to melt it to make a bigger coin or bar and that takes away some value out of it,” said Rajan Mehta, ED, Benchmark MF.

What value will these funds add to your portfolio and overall investment strategy?

The open-ended mutual fund scheme invests money collected from investors in standard gold bullion. Your holding will be denoted in units which will be listed on a stock exchange. These passively managed funds are designed to provide returns that would closely track the returns from physical gold in a spot market and investors can buy and redeem units either directly from the mutual funds or from the stock exchange. In the same way, people willing to invest in Gold ETFs can either enter during the NFO period or buy units once the fund gets listed.

The country currently has 5 Gold ETFs offered by Benchmark Asset Management Company and Mutual Funds like UTI, Reliance, Quantum and Kotak listed on the National Stock Exchange. Presently, the minimum investment is Rs 10,000 and one invests during NFO period and entry load gets applicable on that. So, if you invest Rs 10,000 in a Gold ETF at the time when the price of 10 grams of gold is R 9,650, add an entry load of 1.5% of initial investment and you will be allotted 10.2 units. Each unit will initially represent 1 gram of gold though this will come down gradually, when gold is sold to meet fund expenses.

The prices of these units in the secondary market would reflect the Net Asset Value (NAV) and the supply and demand of the units. The daily NAV of Gold ETF is decided by the price of gold. At the time of redemption, units of the gold ETF would be exchanged for cash and not physical gold. One can buy and sell units from the exchange just like the way he trades in company shares. These units are to be held in Demat form and trading them would attract brokerage charges, which varies from broker to broker. Notably, the brokerage charges would range between 0.4-0.6%, which is generally lower than the usual entry load.

“Right now, the secondary market is available and it makes much more sense because you can see prices on the screen and lock in to those prices. When you apply in primary markets, you don’t know at what price you are going to get gold,” added Rajan Mehta.

However, trading gold ETF units differ in a few ways from trading company’s shares. Since it’s a commodities transaction, Securities Transaction Tax (STT) is not applicable. Also, gold is held by an investor in the dematerialized form or in units. Hence, no wealth tax is levied which is applicable when physical gold exceed Rs 15 lakh. However, gold ETF is a non-equity scheme and would attract a Dividend Distribution Tax (DTT). As per the current norms, a DTT of 14% of the dividend would be applicable for individuals and 22.4% for corporate and institutional investors.

"Right now, under the legislation, gold is considered under the non-equity category. So, debt fund taxation would be applicable in them. For physical gold, the short-term capital gains tax will be applicable till three years of holding. But in gold ETF, for short-term capital gains tax to be applicable, the holding period is only 1 year. So, the incidence of taxation in gold ETF is much lower," added Lakshmi Iyer.

Why should you look at gold as an important asset class for investments?

“It’s a very safe asset, its very liquid and is not backed by any other product. If you look at the current trend, which has happened in the last 6-7 months, we have seen oil prices going at an all time high. We have seen the weakening of the US dollar. We have seen an uncertain time in terms of the global financial markets. That has led to a lot of investment in gold. The reason is that gold would offer you the stability in a most unstable environment. It’s the perfect hedge against inflationary pressures,” said Dharmesh Sodah.

If you decide to invest in gold today understand your needs. If your reason is purely investment, then physical gold is hardly fruitful. This is because the resale value of physical gold in the form of jewellery falls considerably, as making charges or the refining cost from 2-10% of the jewellery cost gets cuts at the time of resale. On the other hand, one can invest in gold bars or coins which are of similar purities as gold ETFs. But if one purchases them from banks or (Non-Banking Finance Companies) NBFCs, most of them do not repurchase them back from buyers. Selling those to other jewelers may again reduce the resale price to some extent.

Dharmesh Sodah stated, “It’s a proven fact that gold has always beaten inflation per se. So, that’s the strongest trend that you would see. Gold is a product which doesn’t offer you a very high return. Gold ETF has to necessarily mirror the gold price.”.

Inflation plus returns, convenient investment vehicle for tax efficient exposure are all good reasons to invest in gold and gold ETFs. So, if you as an investor are clear about the reasons for investments and the issues related there is every reason to include gold as an asset class in your portfolio. Gold ETFs may be an ideal way to join in the gold rush. Experts say these funds can form 5-10% of your portfolio as a form of insurance.

"From a very realistic perspective, if we assess the macroeconomic fundamentals and the inflationary conditions building up in the system, we are talking of a very conservative estimate of 15-20% realistic returns from gold over medium to short-term," Iyer stated.

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