What is a Silver ETF and a Silver ETF Fund of Funds?
A Silver ETF (Exchange-traded Fund) is a fund that, like ordinary shares, is traded on the stock exchanges and tracks the market price of silver. It allows investors to gain exposure to price movements of the precious metal without the hassle of physically purchasing, storing and insuring silver.
Most silver ETFs are physically backed, meaning the fund raises money from investors and uses most of it to purchase and safely store physical silver bars, typically of high purity (99.9%). Each unit or share of the ETF represents a fixed, fractional ownership of that physical silver.
A Silver ETF FoF is a scheme that invests in the Silver ETF, usually from the same fund house. It is preferred by investors who do not want to deal with the nuances of a demat account or want to invest in a diversified manner through systematic investment plans.
Why have some fund houses temporarily stopped accepting new lump sum money into Silver ETF FoFs?
Fund houses such as Kotak, SBI and UTI have stopped accepting lump sum investments in Silver ETF FoFs to prevent retail investors from buying silver at significantly higher domestic prices. Analysts point out that there is a temporary but acute shortage of physical silver in the domestic market. As a result of this shortage and a sharp increase in investor demand, the domestic silver price is trading at an abnormally high premium compared to international import parity prices. In some cases, this premium is reported to be 10-12% or more, while the normal premium is around 0.5%. Silver ETFs and their FoFs purchase silver at this high domestic spot price due to the retail inflows they receive. If an investor were to make a large lump sum investment today, they would be purchasing silver at a price that fund managers believe is overvalued. This carries the risk of an immediate and sharp loss when the premium eventually normalizes.
The limited availability of physical silver also makes it difficult for fund houses to create new ETF units at their indicative Net Asset Value (iNAV), which tracks the physical price. That is why some fund houses have decided to temporarily suspend Silver FoFs.
But why do silver ETFs continue to trade and remain unrestricted?
When an investor buys an ETF, he usually does not buy it directly from the fund house, but from another investor via an exchange. A fund house has no control over transactions on the stock exchange and therefore cannot impose restrictions on the price. As a result, ETFs continue to trade even though they are more expensive than the price of silver.
What should investors do?
Analysts believe silver has strong fundamental tailwinds due to its role in green energy and an ongoing supply shortage, pointing to potential long-term appreciation. However, after the sharp increase of 49% in the last three months and 79% in the last year, retail investors should refrain from lump sum purchases. Ideally, they should invest 10-15% of their total portfolio in gold and silver, building up this allocation slowly and gradually over time.
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