Buying gold: funds vs ETCs

The main player in the UK ETC market is ETF Securities. It offers a range of gold ETCs, including ETFS Physical Gold (which is backed by bullion holdings and tracks the gold spot price) and ETFS Gold, tracking the DJ-UBS Gold sub-index.

The big name in the managed funds space is BlackRock Gold & General, run by Evy Hambro, but gold-dominated funds are also on offer from Investec, Ruffer, Smith & Williamson and SF t1ps. The only gold-oriented investment company marketed in the UK and known to the Association of Investment Companies (AIC) is Golden Prospects Precious Metals.

Which is best for you depends on what you are trying to achieve. But bear in mind that mining shares are still shares at the end of the day. They will wax and wane with equity markets generally, and so will any fund that invests in them. "If you want to get exposure to the gold price in order to diversify your portfolio, then a physical gold ETC is the best tool for the job," says Ben Yearsley at Hargreaves Lansdown.

Another advantage of holding ETCs, which could be a consideration particularly if you're inclined to the golden bubble theory, is that they are extremely liquid. If you want to sell, you can do so immediately, whereas with a unit trust trading just once a day, your sale might not go through until the following afternoon.

But that doesn't mean you should rule out equity-based funds, because when the gold market is doing well, gold mining companies often do even better. They are effectively offering a leveraged play on the spot gold price, as a higher gold price means higher earnings and corporate profit margins, and helps boost the share price further. Just look at the chart of the FTSE Gold Mines index against gold bullion for the past ten years:

And specific actively managed funds may be able to produce markedly higher outperformance: for instance, the CF Ruffer Baker Steel gold fund returned 70 per cent over the year to the end of March, against an increase in the gold price of around 15 per cent.

Of course, the flip side is also true: when gold falls, mining companies are hit even harder - and that'll be even more true now that most gold producers have stopped selling their output forward in order to take advantage of rising prices. So if you take the gold fund route you should understand that you could be letting yourself in for a relatively rough ride if the gold price takes a tumble.

The experts' view

Trevor Steel, who runs the CF Ruffer gold fund, believes that there is a place for both physical gold and mining shares in investors' portfolios, because the two have different strengths. And some independent financial investors (IFAs) take a similar line: for instance, Mike Horseman, managing director of IFA Cockburn Lucas, has made use of both over the past three years or so, and has been "really happy" with the results.

"We use ETFs as a core holding to track the price of bullion, and gold shares in the shape of BlackRock Gold & General or the Ruffer Gold fund as an equity kicker to get exposure to active stockpicking and company management. The funds amount to a geared play on the spot price, so we'll allocate more on that side where there's a greater appetite for risk," he explains.

At Addidi Wealth Management, Anna Sofat uses physical gold ETFs only for portfolios large enough for a specific gold allocation to make sense. "For smaller portfolios we use the BlackRock gold fund because it provides more diverse exposure to other minerals as well as gold, and that helps to reduce volatility," she says.

If you fancy the idea of an actively-managed mining fund, bear in mind that not all offer the same level of exposure to gold as opposed to other precious metals.

Different funds may also have different interests – for example, CF Ruffer's fund focuses in part on future mining projects, with 20 per cent of the fund channelled into companies currently developing new mines. "Over the longer term, identifying and evaluating the most exciting new projects is key to the fund's outperformance of gold bullion, but we don't speculate on exploratory companies," says Mr Steel.

In contrast, the Junior Mining fund concentrates on smaller, more exploratory mining companies worldwide. Tom Winnifrith's SF T1ps Smaller Companies Gold fund, as the name suggests, also looks specifically at small mining companies, which it believes to be undervalued and likely to attract lucrative takeover bids from larger competitors as the gold price rises and cash flows increase.

Finally, there are alternative ways to get a bite of the gold-mining cherry, via broader-based natural resources funds such as those from First State and JP Morgan, which also include base metals and energy. Interestingly, although JP Morgan Natural Resources (with 35 per cent of the portfolio in gold and precious metals) has produced significantly less dramatic returns than the focused gold funds over the past five years, it is up 430 per cent over seven years, while BlackRock Gold & General, the only other fund in the sector with a seven-year history, manages just 300 per cent.

Source: Morningstar. Performance figures to 27 May 2010. Based on an initial lump sum of £100, invested on a bid-to-bid basis