Your Quantum Gold ETF Mutual Fund Is Still The Same

Last year, in February 2013, SEBI permitted Gold ETFs to lend a maximum of 20% of its physical gold holdings under a gold deposit scheme.

A gold deposit scheme is an agreement where a lender lends his physical gold to a bank in return for interest income. On maturity the bank will provide equivalent gold along with the interest payments to the depositor (lender). It’s akin to making a fixed deposit in Gold.

Initially, the fund houses were reluctant as we are even now to lend the gold held under Gold ETF. However, a few have gone ahead with the idea of a gold deposit scheme and thereby earn some interest on the gold lying idle in the vaults.

The media has been hard at criticizing the move of lending the gold under the Gold ETF. An article in Business Standard titled “Your Gold ETF has changed” says that “Gold exchange traded funds (ETFs) have a new element of risk. These schemes which earlier held physical gold equivalent to the unit holders’ investments, now lend a portion of these … This means they no longer directly hold all the gold their investors have paid for. This introduces an element of credit risk to these funds, say experts.”

The two biggest Gold ETFs comprising about half the Industry AUM under Gold ETFs have parted away with a portion of their gold holdings. However, this does not mean that all Gold ETFs would participate in the gold deposit scheme. For example, Quantum Gold ETF^# does not participate in a Gold Deposit Scheme. Therefore, Quantum Gold ETF has not changed and does not bring any new set of risks associated with lending gold.

What Risks?

Broadly speaking, there are three risks associated with the idea of a gold deposit scheme.

Counter Party / Credit Risk:

The biggest positive of gold is that it is no one else’s liability. Under a gold deposit scheme, the physical gold under one’s possession becomes the liability of the counterparty with whom it is deposited usually, a bank. The entire characteristics of gold as an asset class changes once lent out and the process of replenishing the stocks adds to the uncertainty. A situation could arise where the issuer is unable to return the principal physical gold upon maturity or in case of an early redemption. Such inability to return physical gold could arise on account of liquidity problems or general financial health of the issuer. A default by the issuer may result in losses to the Unit holders. Gold deposit scheme being an unlisted and non-transferrable security can be redeemed only with the issuer and hence, is subject to the risk of an issuer’s inability to meet principal and interest payments on the obligation (credit risk). Credit Risk means that the issuer of a Security may default on interest payments or even paying back the principal amount on maturity (i.e. the issuer may be unable to make timely principal and interest payments on the Security) which may result in losses to the Unitholders.

Asset Liability Mismatch

Gold ETFs are open ended funds and therefore technically are open for redemptions on all days. The Gold Deposit Schemes come with a lock in period for six months where no premature withdrawal is permitted. Therefore, if there is a substantial portion of fund assets to be redeemed, the fund manager may find it difficult to meet redemption. Even though this seems like a rare scenario but not an impossible one.

Maturity Risk

Last couple of years has seen dramatic changes in gold regulation in India. In order to avert a current account crisis, the government has tied gold imports to exports under the 80:20 rule thereby limiting gold imports into India. This is akin to a quasi ban on gold imports. In an event of any other major crisis, there is always a possibility that government would undertake further tightening measures of limiting gold imports or a complete freeze on gold imports. Under such circumstances, how would the bank provide back the gold deposited with them? Also, on maturity, will the bank be able to provide gold of the same quality like gold being of an LBMA accredited refiner, purity of 995 fineness, etc, especially if there are restrictive polices in place.

The Argument – no risk, no return

Many would argue that under a gold deposit scheme, the fund is able to earn an additional interest income for the gold lent which would otherwise lie idle in the vaults.

The interest income offered under the GDS is around 0.75% p.a for period of 6 months to 1 year and increases to 1.00% p.a for longer maturities. This means an additional income of 0.75% per year for the gold parked with the bank under the GDS. The maximum amount of gold that can be lent out by a Gold ETF as per SEBI norms is 20%. Even the fund lends its entire permissible quota of 20%, it would translate to an income of 0.15% p.a for the fund unit holders.

It is apparent that the income does not adequately compensate for the risks taken. Even then, any additional income should be secondary. Any changes in the underlying that changes the fundamental characteristics of an asset and brings on additional risk should be treated with caution.

We at Quantum understand the risks associated with lending the gold held by the Gold ETF under the gold deposit scheme which tends to alter the underlying characteristic of gold as an asset and may not be in sync with the reason for which you invest in gold. Therefore, we have avoided taking part in a gold deposit scheme.

In order to put your concerns to rest dear Investor we hereby assure you that Quantum Gold ETF is still the same and has not changed.

# Product Labeling

Name of the Scheme This product is suitable for investors who are seeking* Quantum Gold Fund (An Open-ended Exchange Traded Fund- Gold) • Long term returns • Investments in physical gold. • High Risk (BROWN) * Investors should consult their financial advisers if in doubt about whether the product is suitable for them. Note: Risk is represented as: (BLUE) investors understand that their principal will be at low risk (YELLOW) investors understand that their principal will be at medium risk (BROWN) investors understand that their principal will be at high risk

Above article is authored by Quantum.

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