Now, a golden mutual fund

You may have heard about Midas, the king who had the magical power to convert everything he touched into gold.

However, modern day King Midases (read Indian mutual funds like Benchmark Mutual Fund and UTI Mutual Fund) are going to turn this story upside down.

How it works

These mutual funds will be buying gold for you, with your money, and converting it into paper. This paper, which may be in a physical, or dematerialised, form, is called a unit.

A unit of a mutual fund is exactly like the share/ stock of a company; it can be bought and sold in the stock exchange.

If the share of a company gets its value from assets (like machinery, factory, manpower)/ profits of that company, an asset too backs a mutual fund unit.

Benchmark Mutual Fund will be launching the first such scheme on February 13; it has already got the necessary approval from the Securities and Exchange Board of India.

Such schemes are mostly called Gold Exchange Traded Funds (GETFs), preceded by the name of the company launching this product.

Each unit sold by Benchmark Mutual Fund will represent one gram of gold. For example, if one gram of gold costs Rs 925 at current prices, you will have to pay Rs 925 to buy one unit in Benchmark Mutual Fund GETF scheme. This means you are buying the unit at the official price for gold at that point in time.

Similarly, at the time of selling one gram of gold, if its price is Rs 950, the seller will get Rs 950 per unit or one gram of gold (depending on whether the seller wants money or gold).

The price (NAV) of this GETF unit will increase/ decrease in proportion to the corresponding increase/ decrease in gold prices.

In simple terms, the price of one gram of gold is equal to one unit of this particular scheme.

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Like shares that can be bought/ sold in the stock market, these GETFs will also be traded on the Bombay Stock Exchange and National Stock Exchange.

This buying/ selling allows investors to get out of this scheme or enter the scheme later; you can buy or sell units of this scheme as and when you want to.

Let's suppose you own 10 such GETF units worth 10 grams of gold. Your sister/ niece is getting married in April and you want to gift her gold. Since you own 10 units of the GETF scheme, you can sell these units at the exchange and ask for the gold to be delivered to you. It's exactly the way you would do it in a jeweller's shop; you pay the jeweller money and he gives you gold in return. 

You can also choose to get cash in return when you sell your unit. It is upto you to choose what you want -- gold or cash -- in return for selling your units. Your MF will help you get either.

Wondering how this will happen? Who will give you gold instead of units that you sell? Where will you get this gold from? Here are the answers.

When you invest money in GETF units, the mutual fund takes this money from you and purchases gold. This gold is then deposited with a custodian for safekeeping. The custodian will keep a record of how much gold you own -- this will be represented by your units.

A custodian is a bank or any other institution that acts as an intermediary (facilitator) between you and the mutual fund. Since mutual funds don't have the necessary expertise to hoard or keep vast amounts of gold safely, this job is outsourced to custodians.

For example, Bank of Nova Scotia will be acting as the custodian for Benchmark Mutual Fund's GETF scheme.

Once you sell your units, your mutual fund sends instructions to this custodian to deliver the equivalent amount of gold to you.

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Additional costs

There is a catch here, however. The custodian can be located in some far away geographical area outside the bounds of your municipality. When this gold moves across two municipal limits, octroi duty -- a kind of tax -- is levied on it.

This duty is not paid either by the custodian or the mutual fund. You pay for this duty. So, if you sell units worth Rs 10,000 you will get gold worth Rs 10,000 less the octroi duty.

Investors will have to take this deduction into account before making a decision whether to put their money into this scheme or not. However, you can always sell the units for cash and later purchase gold at your neighbourhood jeweller to save octroi, if you so wish.

On the other hand, if you feel that the prices of gold will double, say in 2010, then you can buy GETF units now with the cash you have. You can later sell them in 2010 or whenever you think you have made some profit or need either gold or cash.

There will always be some sellers willing to sell you the GETF units when you would want to buy since they will be traded freely on the stock exchange. This is the advantage of stock exchanges. They facilitate trading between the buyer and seller with great ease.

The prices of these GETF units will be linked to the prices of gold and they will move in tandem with international gold prices.

If gold prices increase, the value of your GETF units will increase proportionally and vice versa because each unit of your GETF unit is linked to one gram of gold.

Remember, you will not be holding gold in physical form for the period you own these GETF units. The custodian of your mutual fund scheme will handle that headache for you.

Of course, your mutual fund will pay a fee to this custodian for keeping your gold safe. This amount, too, will be charged to you.

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It may be in the form of entry and exit loads; this is a fee that all mutual funds charge their customers while buying or selling units. Normally, a mutual fund will charge you only one of these two loads.

Though the product details will be known only on February 13 when Benchmark will launch this scheme for the first time in India, it will be safe to assume there will be some kind of fee for investing in this scheme as well as at the time of exiting the scheme.

Any mutual fund, be it the ones buying stocks/ debt or the ones buying gold, charge a fee to meet their operational expenses like paying their staff, the commission of the agents, etc. 

If you are buying GETF units there might be entry loads and exit loads (GETFs may call these charges by a different name). These loads, simply put, are fees that you pay to the mutual fund for managing your money and meet their operational expenses.

For instance, say if you are investing Rs 10,000 in GETF units and the entry load is 2.25%, then you will get GETF units worth Rs 10,000 less 2.25%, that is Rs 9775.

The same will be the case when you sell units. The cash in hand will be your total GETF unit value less the exit load and octroi duty.

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Investors will need to take a very careful look at these expenses (the loads and octroi) before taking a call on this product.