Gold Exchange-Traded Funds Come with Their Own ‘Risks’

Gold prices have gone beyond one’s imagination. Gold has always been considered a valuable precious metal and the value has increased dramatically over the past few years. As a store of value and hedge against inflation and failure of a currency system, few things can beat gold. Incorporating gold into a financial portfolio to increase diversi-fiction requires knowing about the different ways to invest in the precious metal.

Gold exchange-traded fund (ETF) is a passive investment strategy in which a fund manager invests in accordance with a pre-determined strategy that doesn’t entail any forecasting on the value of the gold. Riding the bull run in gold, a plethora of funds (ten by last count) have come to the market in India. However, to many it mayseem little “value add”. 

The biggest danger of passive investing is that it is confused with in-dexing. While index investing is a mature approach to investment, passive investment in a single asset class without any elbow room of adjustment is dangerous. An important question is whether passive commodity investment that seeks to replicate index returns might have wider malign consequences. The short answer is “yes”.

The idea of not responding to changes in prices (gold in this case) as a rational decision is an outgrowth of the efficient market theory which has outlived its utility. When one bets on the price of a single com-modity without a mechanism to hedge the downward price risk, then it can only be termed as speculation. Buy-and-hold investing makes a great deal of sense when employed by investors who make reasonable adjustments to their large-sized portfolio allocations in times of high prices. It does not make sense for those who have a small portfolio.

Buy-and-hold and passive investing are not for middle-class investors. Investing involves risk and investing passively increases the risk dramatically as there is no mid-term cor-rection. In a falling market (along with redemption pressures), the impact cost in the physical market (as a result of liquidity risk and off-take risk) is manifold compared to the organised stock market.

Many are attracted to passive investing because it appears to be a no-fuss approach to investing. They do so without making a correct as-sessment of the risk that this approach may cause down the line. After a good bit erosion of investment has been done, it becomes difficult for people to acknowledge that they were responsible for it; they seek ref-uge from taking responsibility for their mistakes in excuses and word games. Then the final resort comes by citing the “risk disclosure” statement in the offer document.

Since the amount of money invested in active strategies (physical gold) is much greater than the amount of money invested in passive strategies (gold ETF), it’s clear that most people still don’t believe oth-ers when it comes to managing the “gold instinct”.

Published in The Economic Times