India lets gold ETFs replace some metal with futures contracts

Big Shift in Gold ETFs: Are Funds Moving Away from Physical gold? Is 'Paper Gold' the Future or a Risk? By Sanket Dhanorkar The Times of India, Mumbai Monday, April 6, 2026 https://economictimes.indiatimes.com/wealth/invest/big-shift-in-gold-etfs-are-funds-moving-away-from-physical-gold-is-paper-gold-the-future-or-a-risk/articleshow/130011547.cms The popular gold exchange-traded fund (ETF) is set to take a path it has not travelled before. In its present form, the gold ETF tracks the price of physical gold and is almost entirely backed by gold bullion. Now, with the blessing of the Securities and Exchange Board of India (Sebi), gold ETFs have the leeway to partially take exposure to the precious metal via gold futures -- a financial instrument, not the physical version. ... Dispatch continues below ... ... ADVERTISEMENT ... 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In June 2024 Sebi allowed gold-backed exchange-traded commodity derivatives (ETCDs), or gold futures contracts, to be counted toward this mandatory allocation. HDFC Gold ETF is the first to make this provision via a notice-cum-addendum dated 15 March 2026. Why does this matter? A gold futures contract is an agreement to buy or sell gold at a fixed price on a future date. It does not amount to holding physical gold; it is a financial contract with gold as underlying security. Theoretically, it is not a big deviation, but enough to count as a change in fundamental attribute of the scheme. Ajay Kumar Yadav, Group CEO & CIO, Wise Finserv, insists nothing changes for the investor. "Giving fund managers the option to use gold futures is really about handling practical situations better," he argues. For example, if there are sudden inflows or a temporary delay in buying physical gold, the gold ETF doesn't have to sit on cash. It can use futures to stay aligned with gold prices. That can help in reducing small inefficiencies, which investors usually don't notice but do matter in the background, remarks Yadav. Futures contracts have some drawbacks. "Futures work a little differently from physical gold. They need to be renewed from time to time (also known as rollover), which adds a small cost," avers Yadav. In certain market conditions, these costs can dent ETF returns, creating a gap with the actual gold return. Besides, in the short term, futures prices can deviate from actual gold prices. Further, settlement of futures contracts may introduce counterparty risk. At expiry, futures can be settled in cash or through physical delivery. There is a possibility that the other side doesn't honour the deal. But there are enough safeguards, insist experts. "Trades happen on exchanges where there is a proper system to settle everything. There are margins, daily checks, and a central mechanism that stands in between. So yes, the risk exists in theory, but in practice it's quite controlled," asserts Yadav. This does not mean that HDFC Gold ETF will now invest only 50% in physical gold. The fund house has clarified that investment in ETCDs will be considered only in rare circumstances where the scheme is unable to buy or sell physical gold due to temporary scarcity of the metal. It will unwind the positions once normal market conditions return. The scheme will retain its core approach to deploy in physical gold to the maximum extent possible. This is evident in its latest portfolio, which held physical gold bars representing 98.65% of its assets. Experts maintain this is not a structural shift to "paper gold" but a liquidity or backup mechanism. Think of ETCDs as a shock absorber, not a replacement for physical gold. Gold ETFs are still required to primarily reflect gold prices. "If anything, this could actually help in keeping the tracking tighter. But from an investor's standpoint, the product you are buying is still the same," says Yadav.  To be sure, the provision for investing in ETCDs exists in other mutual funds as well, including in multi-asset funds. However, many remain skeptical of this move. Investors mostly consider gold ETFs as a simple alternative to holding physical gold. So when the ETF says it may no longer remain fully backed by the metal, it transforms into something else, suggest some. Balakrishnan R., an independent financial analyst and founding team member of credit rating agency CRISIL, insists this shift goes against the original construct of the product. "We buy the ETF for passive exposure to gold, so why introduce an active element to it? You don't change the rules of the game after you invite the participants." Other major fund houses have not yet opted for this path. Chirag Mehta, CIO, Quantum Mutual Fund, remains firmly against it. "Our belief is once you change the underlying holding from physical gold to any other, it changes characteristics, bringing different nuances to consider." He insists any disruptions in physical gold supply will reflect in market prices and get captured in the ETF's net asset value (NAV). Further, gold ETFs have been fairly successful in tracking gold prices over many years through replication through physical gold. Mehta also points out that gold ETFs must buy physical gold that conforms to London Bullion Market Association (LBMA) standards. The underlying in gold futures may not always conform to this, which can be a problem when taking delivery. For investors who simply cannot digest this shift, an exit window will be offered by any fund house opting for this path. But you may incur capital gains tax on such redemption. If staying put, pay closer attention to what your ETF actually holds. 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