Why you should hold gold in your portfolio
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It is quite common to see investors making investments in stocks, bonds, and bank deposits. However, gold investment is just secondary for most of them. Investing only for returns in gold undermines the strategic nature of the asset class. Owning gold is not just about the upside potential but also about minimizing risks to the downside.
Contains downside risk
The risks include radical monetary policies, ultra-low interest rates, exploding world debt, asset bubbles, currencies losing their worth, trade wars, geopolitical conflicts, and market volatility. These global risks have fueled the need for holding an asset like gold. Gold has the potential to help generate higher risk-adjusted returns due to its low correlation to major asset classes.
From 2004 to 2021, a traditional 60-40 Equity-Debt portfolio based on Sensex and Crisil Composite Bond Fund Index had given annual returns of 11.13 per cent with maximum drawdown of 36 per cent. When gold was added to this mix, the 40-40-20 Equity-Debt-Gold portfolio’s annual returns were maintained at 11.13 per cent, but risk was reduced with maximum drawdown being only 21 per cent (see table). Thus, adding gold to an investment portfolio has effectively reduced risk without sacrificing return, making it a must-have in one’s portfolio.
Ways to invest
Even though gold coins and jewellery are still preferred by most, sophisticated investors are starting to move to more efficient forms of purchasing yellow metal. That is because purity is always a concern when buying physical gold. In addition, the purchase of gold bars and coins comes at a premium of 5-15 per cent above gold prices on account of wholesale and retail markups and making charges. This amount plus the 3 per cent GST paid at the time of purchase remains irrecoverable on sale.
Amid increased awareness of the drawbacks of physical gold, financial forms like Gold ETFs are gaining traction. Gold ETFs are listed on the exchanges and invest in physical gold. Each unit of the Gold ETF represents ½ or 1 gram of 24 carats physical gold. Investing in Gold ETFs do not bear any making charges or high premium associated with physical gold. Also, there can be no worry about purity, storage, and insurance of gold. Gold ETFs are traded on the exchange at the prevailing market price of physical gold. Investors can buy or sell holdings at close to the market price without paying a high premium on purchase or selling at a steep discount.
Mutual fund investors who prefer investing via SIP can invest in the Gold ETF via a Gold Savings fund.
Another financial avenue for gold investing is Sovereign Gold Bonds (SGB). Though these bonds pay an annual interest of 2.5 per cent and are tax-efficient, they suffer from low liquidity. They have an 8-year tenure with an exit option from the 5th year onwards only. Also, they are tradable on exchanges but only among their tranches of issuance, thus limiting liquidity and usually seen trading at a discount. So, from a portfolio perspective, Gold ETFs are far more efficient. In addition, unlike Gold ETFs, SGBs are not backed by gold, but have an implicit government guarantee.
Also, fast gaining popularity among the masses is digital gold offerings. These allow investors to invest in 24 karat gold, which is then stored in secure vaults on their behalf. With no limitations on an investment amount, one can start buying gold for as low as Re.1. However, these offerings are not regulated and provide no recourse to investors if something goes wrong. In addition, digital gold is not as efficient as Gold ETFs as there is a loss on resale due to high bid-ask spreads. The 3 per cent GST paid at the time of purchasing too cannot be recovered on resale.
To sum up, gold would provide your portfolio the much-needed fillip, stability and cushioning in unpredictable times by reducing the impact of global economic shocks. The long-term allocation of this asset around 10 – 15 per cent in a portfolio via efficient investment avenues cannot be asserted enough.
The writer is Senior Fund Manager, Alternative Investments, Quantum AMC
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