Why are major mutual funds pausing investments in silver ETFs?
What is a Silver ETF and a Silver ETF Fund of Funds?
A Silver ETF (Exchange-traded Fund) is a fund that is traded on stock exchanges, like a regular stock, 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 buying, storing and insuring silver.
Most Silver ETFs are physically backed, meaning the fund collects money from investors and uses most of it to purchase and securely 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, typically of the same fund house. It is preferred by investors who do not want to deal with the nuances of a demat account or who want to invest in a staggered manner through systematic investment plans.Why have some fund houses temporarily stopped accepting fresh lumpsum money in Silver ETF FoFs?
Fund houses such as Kotak, SBI and UTI have stopped accepting lumpsum investments in Silver ETF FoFs to prevent retail investors from buying silver at significantly inflated domestic prices.Analysts point out that there is a temporary but acute scarcity of physical silver in the domestic market. Due to this shortage and a sharp surge in investor demand, the domestic price of silver is trading at an abnormally high premium compared with international import parity prices. In some cases, this premium has reportedly been 10-12% or more, whereas the normal premium is around 0.5%.Silver ETFs and their FoFs buy silver at this inflated domestic spot price because of the inflows of retail money they receive. If an investor were to make a large lumpsum investment now, they would be buying silver at a price that fund managers believe is overvalued. This poses the risk of an immediate and sharp loss when the premium eventually normalises.
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. Hence, some fund houses have decided to suspend Silver FoFs temporarily.
But why is it that Silver ETFs continue to trade, and there are no restrictions on them?
When an investor buys an ETF, they are typically not buying it directly from the fund house but from another investor through a stock exchange. A fund house has no control over transactions on the exchange and, therefore, cannot impose restrictions on the price. As a result, ETFs continue to trade, even though they are at a premium to the price of silver.
What should investors do?
Analysts believe silver has strong fundamental tailwinds due to its role in green energy and a persistent supply deficit, indicating potential long-term appreciation. However, after the sharp run-up of 49% in the last three months and 79% in the last year, retail investors should avoid making lumpsum buys. They should ideally allocate 10-15% of their overall portfolio to gold and silver, building this allocation slowly and in a staggered manner over time.