What are Gold Mutual Funds

If you do not have demat account and trading account a good way to invest in gold is through Gold Mutual Funds. Gold MFs are fund of funds (FoF) that invest in Gold ETFs. Here the prices move faster and further in both directions than the price of physical gold.

Gold mutual funds are great for newbies

A big advantage with gold mutual funds is that you are not compelled to buy complete units unlike in an ETF. So if you have Rs 1000 to invest in gold you can buy units in a Gold MF but it would be insufficient for a unit of gold in an ETF. You have the option of systematic investment too so you can buy for as little as Rs 100 every month. SIPs are a good way to accumulate gold as an investment. Best of all, you can redeem them at a day's notice, at the prevailing market price (NAV). 

However the fact remains that gold mutual funds have not performed better than gold ETFs. The difference in returns between gold ETF and gold mutual fund belonging to the same fund house ranges from 0.05% for better managed funds to 3% for the poorly managed ones.

Another thing is that the expense ratio in gold mutual funds, which is the fee charged by asset management companies for managing the fund for you, is twofold. On the fund's documents you will see expense ratio but that excludes underlying ETF's charges. You end up paying expense ratio on the fund as well as the ETF it invests in. Yet if you are a stranger to trading, gold funds are not bad at all.

Parameters to look out for

All gold funds invest in gold ETFs -with the exception of DSP Blackrock World Gold Fund- and their returns are close to each other. Long term returns of gold funds however cannot be better than that of gold ETFs. The maximum difference in returns among different gold ETFs is 0.24%. But with gold mutual funds the variation in returns between the best performing fund and least performing fund is higher at 3.38%.

This deviation of returns of the fund from its benchmark, called as tracking error can be accounted to various factors. One of them is that the entire assets of the fund are not invested in the gold ETF. Some portion of the gold fund is held in cash and money market instruments to ensure liquidity for investors who want to redeem their units. Lower the portion allocated to gold ETF, higher will be the tracking error. Similarly higher expense ratio leaves lesser returns in your hands.

Expense ratio of gold mutual funds hovers around 0.25%-0.5%. Add to tthis the expense ratio of the underlying gold ETF which is usually in the range of 0.99%-1.5%. That makes your total expense ratio approximately 2%. The sting of expense ratio gets more painful with larger investment period.

How to choose a gold mutual fund

Currently there are 11 gold mutual funds. You'd find their list in Ready Reckoners section handy. Most of the gold mutual funds were launched in 2011 or post that. Since returns of all gold funds are bound to be trailing close what matters most is the expense ratio. Just go ahead and choose the one with the least expense ratio and whose returns are closest to that of its underlying ETF.

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