Group Project Report - Gold ETF - Financial Markets

Group Project Report Financial Markets
PROJECT REPORT
KEY INNOVATIONS AND FINANCIAL ENGINEERING

– GOLD ETF
Under the Guidance of: Prof. Sandeep Goel

Authors: Nirav Devpura 17P152
Thacker Kaushik Khushabhai 17P176
Ravi Tanna 17P179
Chinmay Gunthey 17P191
Harish Menon 17P197
Pratyush Chawla 17P215
Sarvagya Kala 17P223
Submitted in partial fulfilment for the PGPM in the subject of

Financial Markets
July 2018
1|Page MDI - Gurgaon

Table of Contents
1. Introduction .......................................................................................................................................... 3
2. Financial Innovation/Engineering ......................................................................................................... 4
2.1 Key Innovations and Financial Engineering in financial markets in India ......................................... 5
2.2 Financial Engineered Products in India ............................................................................................. 5
2.3 Innovative Financial Products used in Indian Markets ..................................................................... 6
2.4 Gold ETF ............................................................................................................................................ 8
3. Gold ETF Structure: ............................................................................................................................. 10
3.1 Structure of Gold ETF ...................................................................................................................... 10
3.2 Key Stakeholders ............................................................................................................................. 11
3.3 Working of ETF Market ................................................................................................................... 11
3.4 Advantages of Gold Investing in ETFs ............................................................................................. 11
3.5 Disadvantages of Gold Investing in ETFs ......................................................................................... 12
3.6 Advantages of Gold Investing in ETFs over Mutual Funds .............................................................. 12
3.7 Performance Measure .................................................................................................................... 12
3.8 Key Observations ............................................................................................................................ 13
4. Gold ETF Scenario: .............................................................................................................................. 14
4.1 The Indian Gold ETF Scenario.......................................................................................................... 14
4.2 The Global Gold ETF Scenario ......................................................................................................... 16
5. Benefits of Gold ETF in General .......................................................................................................... 18
5.1 General Benefits.............................................................................................................................. 18
5.2 Benefits of Investing in Indian Market ............................................................................................ 18
6. Risks Associated with Gold ETFs ......................................................................................................... 20
6.1 Counterparty Risk on All Levels....................................................................................................... 20
6.2 Trustee Trouble ............................................................................................................................... 20
6.3 No Exposure to Gold ....................................................................................................................... 21
7. References .......................................................................................................................................... 22

1. Introduction
Financial Innovation is something that is seen by an individual as a new way by which finance can
generate returns, redistribute risk and fuel the economy.
• Among all the adventures of the mankind, financial innovation is the one which is very
unique.
• Financial innovation like innovation elsewhere in business is an ongoing process whereby
private parties experiment to try to differentiate their products and services, responding to
both sudden and gradual changes in the economy.
• Financial innovation can be defined as the act of creating and then popularizing new
financial instruments as well as new financial technologies, institutions and markets.
• It includes institutional, product and process.
Types of Financial Innovation Financial innovation enhances sustainability of institutions and their
outreach to the poor. A useful distinction between different types of financial innovations include:
a. Financial system/institutional innovations: Such innovations can affect the financial sector
as a whole, relate to changes in business structures, to the establishment of new types of
financial intermediaries, or to changes in the legal and supervisory framework. Important
examples include the use of the group mechanism to retail financial services, formalizing
informal finance systems, reducing the access barriers for women, or setting up a
completely new service structure.
b. Process innovations: Such innovations cover the introduction of new business processes
leading to increased efficiency, market expansion, etc. Examples include office automation
and use of computers with accounting and client data management software.
c. Product innovations: Such innovations include the introduction of new credit, deposit,
insurance, leasing, hire purchase, and other financial products. Product innovations are
introduced to respond better to changes in market demand or to improve the efficiency of
product markets.
Significance
Financial innovations help reduce agency costs, facilitate risk sharing, complete the market, and
ultimately improve a locative efficiency and economic growth, thus focusing on the bright side of
financial innovation.
• Countries where financial institutions spend more on financial innovation are better able
to translate growth opportunities into GDP per capita growth. Financial innovation is
associated with higher levels of economic growth.
• Innovative activity of financial intermediaries, which helps countries grow faster at high
levels of income.

• Financial innovation has been shown to increase the material wellbeing of economic
players.
• Positive innovation has helped individuals and businesses to attain their economic goals
more efficiently, enlarging their possibilities for mutually advantageous exchanges of
goods and services.
• Financial innovation, by increasing the variety of products available and facilitating
Financial innovation may also help to moderate business cycle fluctuations.
• Innovations such as credit cards and home equity loans allow households to keep their
consumption smooth, even when their incomes are not.
• The increased availability of credit to businesses allows them to smooth their spending
across short periods when revenues do not cover costs.
Functions of Financial Innovations: The financial innovations help in
1. Moving funds across time and space

2. Pooling of funds;
3. Managing or reallocating risk;
4. Extracting information to support decision-making;
5. Addressing asymmetric information problems;
6. Facilitating the sale or purchase of goods and services through a payment system;
7. Reducing agency cost, and enhancing liquidity
2. Financial Innovation/Engineering
Rapid changes in the corporate finance, bank finance and investment finance have changed the
scenario of financial markets. With the growing competition, the traditional product portfolios of
financial institutions are being replaced with more complex products, which have given birth to a
new discipline known as financial engineering.
Through this report we would focus on concept of financial engineering, new product innovations
through financial engineering. Also, choose one financial instrument/product and analyze its
business model on valued parameter.
Let us first identify the key innovations and financial engineering in the financial markets in India
and/or globe.

2.1 Key Innovations and Financial Engineering in financial markets in India
“Financial engineering involves the designing, the development and implementation of

innovative financial instruments and processes, and formulation of creative solutions to
problems in finance”.
Financial engineering is the life blood of financial innovation – the process that seeks to adapt
existing financial instruments and processes and develop the new ones so as to enable financial
market participants to cope more effectively with the changing world in which we live.
“Financial engineering is continuously focusing on risk reward trade-off by developing the

high yield investment avenues for the investors”
2.2 Financial Engineered Products in India
On risk-reward line, equity and debt can be seen on the two extreme points. Majority of the
financial engineered products are found to be in between these two points. Indian corporate sector
has witnessed innovation in financial products through financial engineering, where attempts have
been made to reduce the risk associated with the instruments, to change some of the basic
characteristics of the instruments and to provide the good amount of return with safety.
Implications of Financial Innovation
Financial innovations have a direct impact on the financial markets. It majorly impacts the asset
prices, international price relationships, and market behaviour. The major implications of
innovations in financial markets are as under:
1. Lower transaction costs

2. More liquidity
3. Diversification of risk
4. More competition in financial markets
5. Increased opportunities for making investment
6. More financial product to select for investment
7. International markets relationships and capital mobility
8. Greater integration of international markets
9. Significant impact of changes in currency rates and exchange rates
Let’s discuss key financial innovations in India and their principal motivating factors
Financial Product Principal motivating factor

Equity linked saving schemes of mutual To offer the benefits of stock market
funds
Debt oriented schemes of mutual funds Tax Advantage

PCD/FCD Pricing and interest rate regulation under
CCI Act
Deep discount/Zero Coupon Bonds Tax Advantage
Puttable and callable bonds Perceived volatility of interest rate
Stock index futures Volatility of equity prices
Interest rate swaps Volatility of interest rates
Money market mutual funds Volatility of interest rates
Specialized mutual funds Investors preference
Exchange traded options Volatility of stock prices
Gold ETFs To channelize the fund from traditional
investment alternative of household to
financial market
REITs To enable investors to have an economic
interest in real estate assets without the need
to buy the physical property
Reverse Mortgage To offer the fixed income to senior citizens
against the mortgage of their residential/
real estate property
Arbitrage Fund equity and derivative funds providing an
ideal way of realizing reasonable returns
from equities with risk hedged by
derivatives
2.3 Innovative Financial Products used in Indian Markets
1) Triple Option Convertible Debentures (TOCD):
• First Issued by Reliance Power Limited with an issue size of Rs. 2,172 Cr.
• There was no outflow of interest for first five years.
• Equity increase was in phases.
• No put option to investors and no takeover threat.
• Reduced dependence on the financial institutions.
The expenses for floating the issue was just 2.62% of the issue size which was very less when
compared to the 10-12% for a general public issue.
2) Deep Discount Bonds:
• The investor got a tax advantage and could eliminate the re-investment risk.
• From the issuer’s point of view also, the issue cost was saved as it involved no immediate
service cost and lower effective cost. The refinancing risk was also eliminated.
3) Floating Rate Notes:

• First issued by Tata Sons with a floor rate of 12.5% and a cap of 15.5% and a reference
rate of 364 T-Bill yield, which was 9.85% at the time of issue.
• The investors would get a minimum return of the floor rate and the maximum return was
the cap rate. They would get higher than floor rate depending upon the fluctuations in the
reference rate.
4) Zero Coupon Bonds:
• It did not involve any annual interest on the bonds. But it had a higher maturity value on
the initial investment for a particular time period.
5) Convertible and Zero Coupon Convertible Bonds:
• Similar to the zero coupon bonds except that the effective interest was lower because of
the convertibility.
6) Secured Premium Notes (SPNS):
• First issued by TISCO in July, 1992.

• These financial instruments were secured against the assets of the company but the
investors had to pay a premium over the market price for these types of instruments.
7) Equity with Differential Voting Rights:
• Issued by Tata Motors, in which the shares were classified as “Ordinary Shares” and “A
Ordinary Shares”.
• The ordinary shares were issued at Rs. 340 per share, had a voting right of one vote per
share.
• On the other hand, the A ordinary shares were issued at Rs. 305 per share but the voting
rights were limited to one vote for every 10 shares. In addition, they were paid extra
dividend of five percentage points.
8) Masala Bonds
• These are rupee-denominated borrowings by Indian entities in overseas markets. Usually,

while borrowing in overseas markets, the currency is a globally accepted one like dollar,
euro or yen.
• Companies issuing masala bonds do not have to worry about rupee depreciation, which is
usually a big worry while raising money in overseas markets. If the rupee weakens by the
time the bonds come up for redemption, the borrower (company) will need to shell out
more rupees to repay the dollars.
9) Junk Bonds
• Issued by corporations of questionable financial strengths or without proven track records

• They tend to be more volatile and higher yielding bonds with superior quality ratings
• They are high yielding, high risk securities

10) Green Bonds
• A green bond is a bond specifically earmarked to be used for climate and environmental
projects. These bonds are typically asset-linked and backed by the issuer's balance sheet
and are also referred to as climate bonds.
2.4 Gold ETF
Gold ETF
The gold ETF being an exchange-traded fund can be bought and sold only on stock exchanges thus
saving you the trouble of keeping physical gold. What's more, unlike with jewellery, coins and
bars which come with high initial buying and selling charges, the gold ETF costs much lower. The
transparency in pricing is another advantage. The price at which it is bought is probably the closest
to the actual price of gold, and therefore, the benchmark is the physical gold price.
How to invest in gold ETFs
Gold ETFs trade on the cash market of the National Stock Exchange, like any other company
stock, and can be bought and sold continuously at market prices. What you need is a trading
account with a share broker and a demat account. One may either buy in lump sum or even at
regular intervals through systematic investment plans (SIP). What's more, you may even buy 1
gram of gold. Create a plan to invest systematically rather than trying to time the market.
Gold ETF charges
Even though there are no entry or exit charges in gold ETF, there are three costs associated with
them. One, is the expense ratio (for managing the fund) which is generally lower compared to
other mutual funds and is around 1 percent. Second, is the broker cost that needs to be accounted
for every time you buy or sell units. Third, which technically is not a charge but impacts returns
is the tracking error. It arises because of the fund's expenses and cash holdings thus not mirroring
actual gold prices
How to pick the right Gold ETF
There are about twelve Gold ETFs in the market. Performance of these funds would largely be in
the same range as it is linked to the movement in in prices of physical gold. Keep an eye on
tracking error and the trading volume. Opt for funds with lower tracking error and higher trading
volumes. There is no lock-in of funds and buying, selling can happen during trading hours (i.e.,
9.15 hrs to 15.30 hrs). Therefore, avoid partial withdrawals or ea ..

Taxation
Gold ETFs are treated as non-equity investments and taxed accordingly. Short-term capital gains
on units held for less than 36 months will be added to investor's income and taxed as per the
applicable slab rate. Long term capital gains on units held for more than 36 months will be taxed
at 20% after providing for indexation.
What you should do
As an investor, gold warrants a space in one' portfolio aimed at long-term goals. Hold not more
than 10 percent of gold in your investment portfolio preferably in paper form. If prices dip,
allocate more to the asset else sell when allocation towards gold in your portfolio goes up.
Top 10 Gold ETFs

3. Gold ETF Structure:
Gold ETF – What is it?
Exchange Traded Fund (ETF) – an investment funds whose shares are traded on an exchange in a
way similar to stocks. The value of the shares of an ETF tracks the value of a particular index,
commodity, currency etc. Precious metals investors are primarily interested in commodity ETFs
that follow the prices of metals. Such ETFs usually allow you to open investment positions that
give returns similar to those from actual positions in metals. To open such a position, you do not
need to buy the underlying metal.
3.1 Structure of Gold ETF
Gold ETFs are backed by physical gold at the back-end. So when an investor purchases a Gold
ETF on the exchange, the entity involved at the back-end buys physical gold. The Gold ETF units
are listed on an exchange, for e.g Gold BeES are listed on the National Stock Exchange (NSE) and
they closely track the actual prices of gold (called spot prices).
10 | P a g e MDI - Gurgaon
3.2 Key Stakeholders
1) Buyers and Sellers – These comprise of both retail and institutional investors.
2) National Stock Exchange – NSE is the exchange platform where all these ETFs are listed, and
it enables the brokers to execute any orders which they receive from the buyers/sellers.
3) Authorized Participant - An Authorized Participant is an entity deputed by the stock exchange

(in this case NSE) to manage the buying and selling of the underlying asset (in this case physical
gold) to create the Exchange Traded Fund. These are usually very large organizations.
3.3 Working of ETF Market
• Buyer and sellers (investors) of Gold ETF use the exchange platform (NSE), so trading is
easy. They can place buy & sell orders, and the broker would execute the same.
• Any additional buying or selling net of this(after the buyer and seller transactions) is settled
with Authorized Participants who buy and sell physical gold. So if there are no buyers and
someone wants to sell, the Authorized Participant would create liquidity, buy buying the
units of Gold ETF from the seller.
3.4 Advantages of Gold Investing in ETFs
• Small Denomination - Going to a retailer will require a decent sum of money to buy a
very small quantity of physical gold, also gold shops will not allow one to buy very small
quantities of pure gold. Gold ETFs can be bought and sold in very small quantities and
traded in them.
• Cost Efficiency - Another advantage of investing in Gold ETFs is that it is cost efficient.
There is no premium like making charges attached to gold ETFs, one can buy at the
international rate without any markup.
• Convenience for Long-term Holding - There is no wealth tax on Gold ETFs (in India),
unlike physical gold. Also, there is no issue of storage where one is worried about
security etc. The units are held in the name of the individual in a Demat account.
Typically, this is a problem if one stores physical gold in good quantities at home or a
bank locker.
• Uniform Availability - There is no issue with respect to the availability of Gold Bees(or
ay other Gold ETF) on the exchange, since the exchange is responsible for trading, for
buying and selling.
• Liquidity - Liquidity is available since this is traded on the exchange and there are
market makers (Authorized Participants) for creating liquidity. So one does not have to
worry about finding a shop to sell or even worry about mark-downs or even testing purity
when faced with selling.
• No Risk of Theft - Since the units of Gold ETFs are in the Demat (dematerialized)
account of the holder, there is no risk of theft.
• Purity - One of the biggest benefits of investing in Gold ETFs the purity is constant.
There is no risk to purity since each unit is backed by the price of pure gold.
3.5 Disadvantages of Gold Investing in ETFs
• No physical item – When required for personal consumption, you cannot convert gold etfs
into physical gold as they are gold contracts and derivates per se.
• Other costs – When you invest in gold etf, there are certain other charges like demat
account costs, brokerage fees and also sometimes management fees of the fund house
managing these commodities which you to pay. This impacts your returns significantly.
3.6 Advantages of Gold Investing in ETFs over Mutual Funds
• Expense Ratio – ETFs have comparatively much lower expense ratios as compared to
mutual funds because of entry load and exit load.
• Trading principle - ETFs can be traded like stocks throughout the day while open-ended
mutual funds can be accessed only at the end of the day
• Tax efficiency and Capital Gains - ETFs are more tax efficient because of their in-kind
creation and redemption process, which allows for arbitrage and pricing efficiency. In the
case of ETFs, only the transacting shareholder is taxed, while the gains are distributed to
the other shareholders. On the other hand, the transactions of mutual funds generate tax
consequences for all the unit holders.
• Transparency - ETFs are more transparent than mutual funds as they declare their daily
holdings, unlike mutual funds, which declare their holdings at the end of the quarter.
3.7 Performance Measure
The performance of Exchange Traded Funds (including Gold ETFs) and Index Funds is measured
by an indicator called “tracking error”. Tracking error is nothing but a measure that sees the
divergence between the ETF (or index Fund) performance and the performance of the benchmark
it seeks to copy. So lower the tracking error, better the ETF.
Comparative Analysis of Gold ETF (India & USA) v/s Nifty Index Fund v/s Sensex Index
Fund
• SBI Gold ETF – Indian Gold ETF fund

• ICICI Prudential Nifty iWIN – Indian Nifty 50 Index fund
• SBI – Sensex ETF – Indian Sensex Index fund
• Nifty 50 – Market Index
• Sensex – Market Index
• SPDR Gold Shares – US Gold ETF fund
• Tracking error - Tracking error is the difference between the return on a portfolio or fund,
and the benchmark it is expected to mirror (or track)
• Volatility – It is a measure of systematic risk, of a security or a portfolio in comparison to

the market as a whole.
• Expense Ratio - The expense ratio of a stock or asset fund is the total percentage of fund
assets used for administrative, management, advertising, and all other expenses.
1 Year Return 5 Year Return Tracking Volatility Expense

error Ratio
SBI Gold ETF 3.87% 2.61% 0.06% -0.307
ICICI 13.03% 14.43% 0.98 0.05%

Prudential
Nifty iWIN
SBI – Sensex 15.87% 14.29% 0.02% 0 0.07%

ETF
Nifty 50 13.21% 14.60%
Sensex 16% 14.36%
SPDR Gold -2.73% -0.08% 0.51% 0.85 0.40

Shares
3.8 Key Observations
• Indian gold ETF fund has performed poorly as compared to other benchmarks, but has
significantly surpassed the US gold ETF fund.
• Tracking error signifies that Indian ETF fund has been more successful in mimicking its
benchmark fund against the US ETF fund.
• In addition to that, In comparison with Indian Index funds, US fund has higher expenses.
4. Gold ETF Scenario:
4.1 The Indian Gold ETF Scenario
The idea of Gold ETF was officially conceptualized by Benchmark asset Management Company
Private Limited in India in the year 2002, but the proposal that was rejected by SEBI initially was
launched later in March 2007.
In India, the total Assets Under Management (AUM) of ETF funds were Rs. 63146 Cr as on
October 2017. The AUM of exclusive equity funds during the same period was Rs. 632408 Cr. A
comparison of the average AUM of Gold and other ETFs is given below:
As can be seen from the graph, AUM of other ETFs (mainly consisting of equity ETFs) have
increased by a CAGR of 128% (from Rs. 4903 Cr in 2014 to Rs. 58068 Cr. In 2017). The primary
reason for this is because the Employee Provident Fund Organization (EPFO) started investing in
ETFs in August 2015.
Gold ETFs, however, have dropped by 12% CAGR (from Rs. 7327 Cr in 2014 to Rs. 5078 Cr. In
2017). The primary reason for this is related to the movement of gold price. In dollar terms, Gold
peaked out in 2011 and by the end of 2015 had lost nearly half of its value. It has managed to gain
ground from its 2015 lows, but the recovery over the past three years has been quite fragile. In
rupee terms, gold has been languishing around the Rs. 30,000 (per 10 gram) band for the past few
years, thereby not offering much incentive for long-term investors to put money into these
instruments.
Investors have pulled out Rs. 835 Cr from the Gold ETFs in 2017-18, making it the fifth
consecutive financial year of outflow. In fact, except for a couple of months, India has seen net
negative flows in gold ETFs from February 2013. Even in terms of inflows, from triple-digit crore
of inflows until 2012, it has now dwindled to low single-digit and almost nil in some months.
This is also reflected in the performance of Indian Gold ETFs:
Another reason for the decreasing attraction of gold ETFs in India is the introduction of sovereign
gold bonds (SGBs) by the government. Budget 2015 had introduced a sovereign gold bond scheme
with the aim to encourage people to buy more of electronic or paper gold instead of buying gold
in the physical form. These sovereign gold bonds are instruments that can be bought in demat form
and come with an 8-year lock-in.
SGBs are listed on the stock exchanges, in case you wish to redeem prematurely. The minimum
investment was kept at 2 gram (reduced to 1 gram in the subsequent issue), with a maximum limit
of subscription of 500 gram per person per fiscal year (April-March). But where it scored over
gold ETFs was that it gave an interest rate (2.75% per annum initially, and 2.5% subsequently).
An ETF, on the other hand, charges an annual expense ratio of usually 0.9-1.1% per annum. This
reduces your returns.
4.2 The Global Gold ETF Scenario
Gold ETFs initial growth can be accounted towards its backing by gold, thus making it a safe
instrument. In the times when equity volatility was at peak, due to the housing crisis, Gold ETFs
proved to be a safe bet for investors, compensating for the low returns against the low risk.
However, as the markets stabilized, the preference for gold ETFs decreased, and thus equity
markets gained preference
The global Gold ETF volumes seem to be declining, due to the increased preference of investors
over equity holdings as compared to Gold ETF
As of
June 2018 30/06/2018
Total AUM Change Flows Flows (%

(bn) (tonnes) (US$mn) AUM)
North America 50.2 -44.4 -1,852.9 -3.69%

Europe 42.3 0.5 52.3 0.12%
Asia 3.9 -3.5 -148.5 -3.79%
Other 1.4 -2.0 -89.1 -6.24%
Global inflows 17.3 745.4 0.76%
Global outflows -67.0 -2,783.5 -2.84%
Total 97.9 -49.3 -2,038.1 -2.08%
The ongoing belief among investors is such that the gold ETFs prices would increase when the
volatility among the other instrument rises, as gold is considered to be less volatile and a safe bet.
However, the rise in cryptocurrencies might lead to decreased preference of gold ETFs.
This can be attributed to the lower returns that the ETF offers as compared to other instruments.
Investors
also believe
the outflows
are due to
the
speculation
and trading
and short
future
games
5. Benefits of Gold ETF in General
5.1 General Benefits
1. Hedge against inflation: Gold is considered a safe investment because it can be used as a
protection against currency fluctuation and inflation.
2. Simple trading: You need to buy a minimum of 1 unit of gold – equal to 1 gram of gold –
to start trading in gold ETFs. Buying and selling the units works just like equities – you can
trade through your stockbroker or ETF fund manager.
3. Open trading: Gold prices on the stock exchange are publicly available. You can check the
gold prices for the day or the hour without any confusion.
4. Easy transactions: You can buy and sell gold ETFs at any time of the day – when the stock
exchanges are open – from any part of the country. You will also not be affected by local
price differences in gold due to VAT or other taxes.
5. Inexpensive: Gold ETFs listed on the stock exchange have no entry or exit load for purchase
or sale of units. You have to pay only around 0.5 to 1 percent as brokerage charges.
6. Tax benefits: Gold ETFs older than a year attract long-term capital gains tax. However,
there is no VAT, Wealth Tax or Securities Transaction Tax on gold ETFs.
7. Secure investment: Gold ETFs are an easier investment than physical gold as there are no
concerns over theft, secure storage or payments such as locker charges or making charges.
8. Safe asset: Gold prices do not usually fluctuate very heavily. Even if your returns on equities
decrease, gold ETFs could prevent you from sustaining big losses.
9. Portfolio diversification: Gold ETFs are a good way to add diversity to your portfolio.
Amid unstable market conditions, a diversified portfolio can give your better returns and
reduces your risks.
10. Loan collateral: Your gold ETFs can function as collateral security if you want to borrow
from financial institutions.
5.2 Benefits of Investing in Indian Market
1. Gold has given a phenomenal return in the last decade in India and also acts as a hedge
against inflation. (Figure 1)
2. It combines the simplicity of gold investment and flexibility of stock investment and is
traded on major stock exchanges including BSE Mumbai
3. Gold shares a very low correlation with equity so whenever there is some trouble in the
economy, you’ll find gold spiking up. In other words, it shares an inverse relation with
equity.
4. In the last decade, gold price had rallied from Rs 8000 to Rs 31000 per 10 gm giving a CAGR
of 14.51%. A steep rally since the stock market crash in 2008 and since then it never looked
back.
5. Adding gold in your portfolio systematically over the years would be a right choice since it
not only helps to fight inflation but also acts a safe haven during any market collapse.
Figure 1: Performance of Goldman Sachs Gold BeEs in last decade in India
(Source: Why to Invest in Gold ETF in India – elearnmarkets.com article)
6. Risks Associated with Gold ETFs
6.1 Counterparty Risk on All Levels
Unlike physical gold bullion—which is a tangible asset—ETFs are a financial product that have
counterparty risk. Counterparty risk is present when there’s a possibility the other party in an
agreement will default or fail to live up to their obligations.
One of gold’s primary benefits is being the only financial asset that is not simultaneously
somebody else’s liability. Therefore, these ETFs are a poor substitute.
When we look at how these ETFs function, the problems quickly become apparent.
Let’s analyze the operations of the world’s largest gold ETF—the SPDR Gold Trust (GLD). To
gain exposure to the price of gold, investors buy GLD shares through an Authorized Participant.
An Authorized Participant is usually a large financial institution, like a market maker, which is
responsible for obtaining the underlying assets necessary to create ETF shares.
When they do so, they are buying shares in the funds trustee—the SPDR Gold Trust. The trustee
then uses a custodian, in this case HSBC, to source and store the gold for them. As the custodian
is tasked with sourcing and storing the gold on behalf of the trustee, they are a major counterparty.
Herein lies the first problem. Many investors buy gold as portfolio insurance against a systemic
failure in the financial system. As GLD is intertwined with one of the world’s largest banks, it
doesn’t fit this purpose. If HSBC became impaired, GLD shares could be negatively impacted.
But the problems go deeper. Custodians like HSBC use sub-custodians, such as the Bank of
England, to source and store gold. So, in addition to carrying custodian risk, investors also have
sub-custodian risk.
All of this suggests a lot of counterparty risk.
6.2 Trustee Trouble
Based on old LBMA rules, there are no written contractual agreements between sub-custodians
and the trustees or the custodians. As a result, the ability of trustees and custodians to take legal
action against sub-custodians is limited. Therefore, the trustee is on the hook for any negligence.
It turns out that trustees don’t insure their gold holdings. They leave the responsibility of insurance
to the custodian. And custodians only insure the contents of the vaults for limited general insurance
cover. Such coverage falls greatly short of the value of the gold held inside the vaults.
Putting it all together, if anything happens to any of the counterparties, the investor has zero
recourse. Besides carrying major risks, there is another issue with gold ETFs.
6.3 No Exposure to Gold
Gold ETFs don’t give you exposure to gold—but, it’s true. The GLD prospectus states “GLD
represents fractional, undivided interest in the Trust.” When you invest in a gold ETF, you are
buying shares of the Trustee. Basically, you are a shareholder of the trust, not a gold holder.
As such, GLD shares represent a paper claim on gold, not gold itself. This negates a major reason
for owning it—protection during crises. If the economy collapsed and brought down a part of the
financial system with it, the Trustee will settle your claim in cash, not gold.
The real irony is the price of gold could be skyrocketing and the ETFs could be going bankrupt at
the same time.
Given these issues, long-term investors would be wise to avoid gold ETFs.
7. References
https://www.gold.org/data/gold-etf-holdings
https://www.amfiindia.com/research-information/aum-data/aum-aaum-disclosure
https://www.indiainfoline.com/mutualfunds/etf
https://economictimes.indiatimes.com/mf/mf-news/investors-continue-to-exit-from-gold-etfs-in-
april-prefer-equities/articleshow/64160322.cms
https://www.fincash.com/l/investing-gold-etfs
https://www.sunshineprofits.com/gold-silver/dictionary/gold-etf/
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ETFs-falling.html
https://economictimes.indiatimes.com/icici-prudential-nifty-etf/mfreturns/schemeid-18653.cms
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https://www.bankbazaar.com/gold-rate/top-10-gold-etf-
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Accelerating Growth of Gold ETF in India, Dr. M. M. Goyal O.S.D., Principal, PGDAV
College, Ring Road, Nehru Nagar, New Delhi, India

Group Project Report - Gold ETF - Financial Markets

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Group Project Report - Gold ETF - Financial Markets

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Group Project Report Financial Markets

KEY INNOVATIONS AND FINANCIAL ENGINEERING

Under the Guidance of: Prof. Sandeep Goel

Submitted in partial fulfilment for the PGPM in the subject of

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Functions of Financial Innovations: The financial innovations help in

1. Moving funds across time and space

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2.1 Key Innovations and Financial Engineering in financial markets in India

“Financial engineering involves the designing, the development and implementation of

“Financial engineering is continuously focusing on risk reward trade-off by developing the

2.2 Financial Engineered Products in India

Implications of Financial Innovation

1. Lower transaction costs

Financial Product Principal motivating factor

Debt oriented schemes of mutual funds Tax Advantage

2.3 Innovative Financial Products used in Indian Markets

1) Triple Option Convertible Debentures (TOCD):

2) Deep Discount Bonds:

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• First issued by TISCO in July, 1992.

• These are rupee-denominated borrowings by Indian entities in overseas markets. Usually,

• Issued by corporations of questionable financial strengths or without proven track records

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10) Green Bonds

2.4 Gold ETF

How to invest in gold ETFs

Gold ETF charges

How to pick the right Gold ETF

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What you should do

Top 10 Gold ETFs

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3. Gold ETF Structure:

Gold ETF – What is it?

3.1 Structure of Gold ETF

3.2 Key Stakeholders

3) Authorized Participant - An Authorized Participant is an entity deputed by the stock exchange

3.3 Working of ETF Market

3.4 Advantages of Gold Investing in ETFs

3.5 Disadvantages of Gold Investing in ETFs

3.6 Advantages of Gold Investing in ETFs over Mutual Funds

3.7 Performance Measure

• SBI Gold ETF – Indian Gold ETF fund

• Volatility – It is a measure of systematic risk, of a security or a portfolio in comparison to

1 Year Return 5 Year Return Tracking Volatility Expense

SBI Gold ETF 3.87% 2.61% 0.06% -0.307

ICICI 13.03% 14.43% 0.98 0.05%

SBI – Sensex 15.87% 14.29% 0.02% 0 0.07%

Nifty 50 13.21% 14.60%

Sensex 16% 14.36%

SPDR Gold -2.73% -0.08% 0.51% 0.85 0.40

3.8 Key Observations

4. Gold ETF Scenario:

4.1 The Indian Gold ETF Scenario

This is also reflected in the performance of Indian Gold ETFs:

4.2 The Global Gold ETF Scenario

Total AUM Change Flows Flows (%

North America 50.2 -44.4 -1,852.9 -3.69%

5. Benefits of Gold ETF in General

5.1 General Benefits

5.2 Benefits of Investing in Indian Market

Figure 1: Performance of Goldman Sachs Gold BeEs in last decade in India

(Source: Why to Invest in Gold ETF in India – elearnmarkets.com article)