HDFC gold ETF can invest in derivatives under new rules; here's what investors should know

HDFC Mutual Fund has introduced a key change to its gold exchange-traded fund (ETF), allowing investment in gold derivatives. The mutual fund house has clarified that it will invest in commodity derivatives only during temporary shortages of physical gold and will unwind them once normal market conditions return.

According to a recent HDFC addendum to the scheme information document (SID), the fund can now allocate a significant portion of its assets to instruments such as exchange-traded commodity derivatives (ETCDs), essentially futures contracts. The change comes into effect April 22.

While the HDFC Gold ETF will continue to remain largely tied to physical gold, the change gives it more flexibility in how it gains that exposure.

“Over the past six months, gold has remained quite volatile. The decision to allow the use of derivatives has been taken to help fund managers manage this better. They will now have the option to use derivatives, which could potentially improve returns for investors,” Kranthi Bathini, Equity Strategist at WealthMills Securities Pvt Ltd, said.

Under the revised framework, the scheme may invest up to 50 percent of its net asset value in gold-related instruments such as derivatives, gold deposit schemes (GDS), and the gold monetisation scheme (GMS).

The exposure to GDS and GMS is capped at 20 percent. Unused portion of this cap can be deployed into derivatives such as exchange-traded commodity derivatives (ETCDs).

This marks a clear expansion from the earlier structure, where the fund was largely expected to hold physical gold and have limited exposure to other instruments.

HDFC Mutual Fund has issued a statement clarifying that investment in ETCDs will only be considered in rare circumstances, when the scheme is unable to buy/sell physical gold due to a temporary scarcity.

Once the market normalises and the scheme can buy or sell physical gold, the corresponding ETCDs are expected to be unwound.

“The scheme does not intend to use ETCDs as part of the scheme’s day-to-day strategy. The core approach of the scheme remains unchanged; scheme assets will be deployed in physical gold to the maximum extent possible, and the balance will be in cash/net current assets, as per the scheme’s asset allocation,” it said. The scheme held 15,262 kg physical gold bars with purity of 99.5 percent fineness or above, representing 98.65 percent of scheme assets. Cash, cash equivalents and net current assets accounted for 1.35 percent of scheme assets as of February 28, it added.

What does it mean for investors?

The move allows the fund manager more flexibility. Instead of always buying and storing physical gold, the ETF can now use derivatives such as futures contracts to gain exposure to gold prices. These contracts track the price of gold but do not involve owning the metal.

There are several reasons why a fund would prefer derivatives. One is cost efficiency. Holding physical gold involves storage, insurance, and logistics costs. Derivatives can sometimes provide similar exposure without these overheads.

Another factor is liquidity. Futures markets can be more liquid, especially during times of high trading activity. This allows fund managers to quickly adjust positions in response to market movements.

Gold is generally used as a hedge against volatility, so the change is unlikely to alter the strategy in a major way. It is not mandatory — fund managers have the discretion to use derivatives rather than an obligation.

“These changes remain within the existing regulatory limits on fund holdings. So, the impact on returns may not be drastic, but it could offer some additional benefits to investors,” Bathini said.

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