What is Silver ETF? Meaning, Types, Benefits & Limitations

Investing in precious metals has always been a popular choice for Indians. With the introduction of Silver ETFs, you now have a modern way to add the shine of silver to your investment portfolio. Silver ETFs are Exchange Trade Funds that invest in silver. An investor can buy units or shares of these ETFs and get investment exposure to silver. Let’s uncover the world of silver ETF investing and explore what it means for you as an Indian investor.

What are Silver ETFs?

Silver ETFs or Silver Exchange Traded Funds are investments that track the value of silver by investing in physical silver or in assets that are linked to physical silver. These funds enable you to have exposure to silver without the complication of keeping physical metal. When you buy shares of a silver ETF, you are basically investing in silver indirectly.

An ETF invests in silver, and every share you own of the ETF represents an ownership stake in that silver. However, the value of silver ETFs rises or falls with the market price of silver. This is why silver ETFs are a great choice for those who want access to silver prices but not the storage/security concerns.

One key advantage of silver ETFs is their liquidity. You can buy and sell shares of these ETFs on stock exchanges, just like you would with stocks. This means you can easily convert your investment to cash when needed, unlike physical silver which might take time to sell.

Suppose the current market price of silver is ₹75 per gram. You buy 100 units of a silver ETF, where each unit represents 1 gram of silver. If the silver price rises to ₹80 per gram, your ETF investment value increases to ₹8,000 from ₹7,500, giving you a ₹500 gain.

Now that you understand silver ETF meaning, it is time to learn about the types of silver ETFs.

Types of silver ETFs

When it comes to silver ETF, there are primarily two types you should know about:

1. Physically-backed Silver ETFs

These funds directly own physical silver stored in secured vaults. If you invest in these ETFs, you’re purchasing a portion of that silver. The value of the fund closely follows the price of silver on the market. This kind of ETF appeals to investors who want a direct connection to the precious metal.

2. Futures-based Silver ETFs

Rather than owning physical silver, a silver fund’s ETF purchases silver futures contracts. They do this by buying and selling these contracts in an attempt to track the price of silver. However, its price may not always match silver’s market price exactly due to factors like contract rollovers and market conditions.

Features of Silver ETFs

Silver ETFs come with several unique features that make them an interesting investment option:

Purity

Most silver ETF funds in India are required to invest in silver of 99.9% purity. This ensures that you’re getting exposure to high-quality silver, which is essential for maintaining the value of your investment.

Acts as a Hedge against Inflation

Like gold, silver is often viewed as a hedge against inflation. As the value of currency drops, silver prices rise, which may protect your purchasing power.

No Storage Costs

Unlike physical silver, silver ETFs don’t need security or storage. The fund does this for you, saving you money and aggravation.

Reduced Portfolio Risk

Adding silver to your investment mix can help diversify your portfolio. Since silver often moves differently from stocks and bonds, it can potentially reduce overall portfolio risk.

How Does a Silver ETF Work?

The workings of a silver ETF are quite straightforward. Here’s a simple breakdown:

• The fund company buys and stores physical silver.
• They create ETF shares representing this silver.
• You buy these ETFs through your broker on the stock exchange.
• The value of your ETF changes with the market price of silver.
• You can sell your ETFs anytime during market hours.

This structure allows you to gain exposure to silver prices without dealing with physical silver yourself.

Pros of Silver ETFs

Investing in silver ETFs comes with several advantages:

Cost efficiency

Buying and storing physical silver can be expensive. With silver ETFs, you avoid costs like storage, insurance, and authentication. For example, storing 10 kg of silver safely might cost you around ₹5,000 per year, while the expense ratio of a silver ETF might only be about 0.5% of your investment value.

Liquidity

Silver ETF trading is as easy as trading stocks. You can buy or sell shares instantly during market hours. This is a significant advantage over physical silver, which might take days to sell. If you need to convert ₹50,000 worth of silver to cash quickly, you could do so within minutes with an ETF, but it might take much longer with physical silver.

Flexibility

You can invest small amounts in silver ETFs, unlike physical silver, which you need to buy in standard weights. For instance, you could invest just ₹1,000 in a silver ETF, whereas the smallest silver coin you might buy could cost ₹5,000 or more.

Dividend potential

Some silver ETFs may pay dividends from the income they generate by lending the silver they hold. While not all ETFs do this, it’s an additional benefit that physical silver can’t offer.

Cons of Silver ETFs

Like any investment, silver ETFs also have some drawbacks:

Market volatility and price risk

Silver prices may sometimes show volatility. For example, in 2020, silver prices fluctuated between ₹41,000 and ₹73,000 per kg. This volatility can lead to significant short-term losses if you need to sell when prices are down.

Tracking error

Due to factors like fund expenses and trading costs, silver ETFs may not perfectly track silver prices. A tracking error of even 0.5% could mean a difference of ₹500 on a ₹1,00,000 investment over a year.

Counterparty risk with derivatives

There is a risk of counterparty default for ETFs based on futures contracts. Though rare, an event like that can impact the fund’s performance.

Liquidity issues

In periods of market stress, the bid-ask spread for ETF shares may widen and increase your trading costs. A spread that’s ordinarily ₹0.10, for example, may rise to ₹0.50 or beyond in turbulent times.

Tax implications

As an investor, you must thoroughly understand silver ETF taxation. In India, gains from silver ETF investments held for less than 1 year are taxed as short-term capital gains at your income tax slab rate. Long-term gains (over 1 year holding period) are taxed at 12.5%.

Things to Consider Before Investing in Silver ETFs

Before you jump into silver ETF investing, consider these factors:

• Risk Appetite: Silver prices can sometimes be volatile. If a 20-30% swing in your investment value makes you uncomfortable, silver ETFs might not be for you.
• Expense Ratio: Look for ETFs with lower expense ratios. A difference of 0.2% in expense ratio could mean ₹200 less return per year on a ₹1,00,000 investment.
• Tracking Error: Choose ETFs that closely track silver prices. A lower tracking error means the ETF is doing a better job of replicating silver’s performance.

How to Invest in Silver ETF in India?

Investing in Silver ETF in India is a straightforward process:

• Open Demat Account & Trading account if you don’t have one.
• Choose a silver ETF you want to invest in.
• Place a buy order through your broker or trading platform.
• You can invest a lump sum or set up a systematic investment plan (SIP).

Remember, you’ll need to have funds in your linked bank account to make the purchase.

SEBI Rules for Silver ETF

The Securities and Exchange Board of India (SEBI) has set specific rules for silver ETFs to protect investors:

• Investment Ceiling: Silver ETFs must invest a minimum of 95% of their active net assets in silver and silver-linked devices, keeping them closely linked to silver prices.
• Tracking Error: The silver ETF tracking error must be less than 2%. This helps ensure that the ETF’s price performance closely tracks silver.
• Expense Ratio: SEBI caps the total expense ratio for silver ETFs at 1% of daily net assets. This helps keep costs low for investors.
• Purity: Silver ETFs must invest in silver of 99.9% purity (999 fineness) or above. This guarantees that you’re getting exposure to high-quality silver.

Factors Affecting Silver ETF Share Price India

Several factors can influence the share price of silver ETFs in India:

• Global silver prices: International silver prices directly impact Indian silver ETF prices.
• Rupee-Dollar exchange rate: Since silver is priced in dollars globally, the exchange rate affects the rupee price of silver.
• Industrial demand: Silver has many industrial uses, so economic activity can influence its price.
• Investment demand: Increased investor interest in silver can drive up prices.
• Gold prices: Silver often moves in tandem with gold, though usually with more volatility.

For instance, if global silver prices rise by 5% and the rupee depreciates by 2% against the dollar, your silver ETF’s value might increase by around 7%.

Conclusion

Silver ETFs offer a modern way to invest in silver, combining the benefits of precious metal investing with the convenience of stock trading. While they come with their own set of pros and cons, they can be a valuable addition to a diversified investment portfolio for the right investor.