New gold bonds can add shine to your portfolio

The Government of India, in consultation with the Reserve Bank of India, has decided that Sovereign Gold Bonds (SGBs) 2018-19 (Series II) will be open for subscription from October 15 to 19. The issue price of the bond will Rs 3,146 per gm, with settlement on October 23, 2018. Gold bonds issued by the government are a great investment idea as financial markets remain volatile. For those who apply online, the SGBs will be at a discount of Rs 50 per gram, that is, issue price would be Rs 3,096 per gm of gold. The current market price of 10 gm gold is Rs 31,560.

With a fixed interest of 2.5% per annum, and the potential to earn more if the market-linked gold price moves up, SGBs are an attractive opportunity. DNA Money talks to experts about the key things to know as you gear up for gold bond buys in Dussehra week.

Good as gold

Gold as an asset class plays an important role in one's portfolio. Its negative correlation with other asset classes makes it an effective tool for diversification. It is also an excellent hedge against implications of rising inflation, political instabilities and falling currency on one's portfolio. Hence, under the current market conditions, holding 10-15% of the overall portfolio in gold is advisable. However, SGB is not the best tool for realising objective, said Manish Kothari, director & head of mutual funds, Paisabazaar.com,

As an asset class, gold is a hedge. The world continues to remain in state of great disequilibrium, both with respect to the global economy, as well as geopolitics. "Given the macroeconomic picture, gold will be a useful portfolio diversification tool and will help you reduce the overall portfolio risk," said Chirag Mehta, senior fund manager - alternative investments, Quantum MF.

Pros and cons

There are quite a few advantages of investing in gold bonds. Firstly, when compared to all other gold investments, the interest rate offered for the gold bond scheme is fairly attractive, said Samant Sikka, co-founder, Sqrrl Fintech. Next, you can use your bond investment papers for loans. "This means your bonds can be kept as collaterals for getting loans," he said. Also, since you are not purchasing physical gold and your sovereign bonds are in the forms of demat and digital forms, the risk of theft is practically zero, he added.

SGB allows you to invest in gold minus the hassles of safe storage and purity concerns. Adhil Shetty, CEO, BankBazaar, said: "It provides additional advantages over physical gold, such as tax-free gains from the maturity proceeds in eight years."

But as with any investment in gold, investors must proceed with caution. Gold acts well as a hedge against market volatility. However, your returns expectations from gold need to be moderated as returns in recent years have been very poor, Shetty pointed out.

A big issue with investing in gold bonds is its lock-in period, which is five years. "The overall maturity of eight years is a tad too long. Redeeming before maturity will require you to pay capital tax. In comparison, phsical is something you can sell anytime," said Sikka. Also, the interest earned on SGB is taxable.

At the time of maturity, the gains will depend on the then price of gold. Although very low, there's a scope of getting negative returns based on gold price movements. For example, the price of gold today is less than what it was a year back, which means negative returns.

Asset allocation

From purely an investment portfolio constituent, gold bonds are pretty good. According to Sunil Sharma, chief investment officer, Sanctum Wealth Management, SGBs, from an asset allocation perspective, are good and every portfolio should hold a small allocation to gold. "Physical gold often has storage costs, while SGBs are government securities and an electronic substitute for physical Gold. Resale or sale of gold is also not an issue. The traditional jewelry market has a high bid-ask spread. In other words, the price to buy and sell are very wide," Sharma said.

With gold bonds, you don't need to do any due diligence as well. The investor will receive the ongoing market price at the time of redemption. Since the bond is issued by the Reserve Bank on the behalf of GOI, it is a secured investment. With SGB, the issue of purity is also taken care of. "The investor will not have to worry about the purity and legitimacy of the gold that he purchases. Nor does the investor have to pay any add on charges that are normally levied by jewelers such as making fees. The bonds are held in the books of the RBI or in demat form eliminating risk of loss," Sharma added.

Taxation benefit

Taxation is another benefit, in the form of capital gains tax exemption on redemption. Currently, the bonds are trading at a discount to prevailing gold prices, to compensate for the reduced liquidity. Additionally, there are no expense ratios such as charged by Gold Exchange Traded Funds, so they are an attractive alternative to ETFs as well. Traditional gold does not provide income, whereas these holdings provide annual interest.

Illiquid compared to physical gold

The downside is that these bonds are not very liquid and the investor must be prepared to hold to maturity. Kothari of Paisabazaar said sovereign gold bonds suffer from very low liquidity when compared to other alternatives like gold funds. "While they can be traded on exchanges, their trading volume is too low or nil. This will make portfolio rebalancing, if required, difficult. In contrast, gold funds are as liquid as other mutual funds and can be bought and redeemed at NAV during business days. Gold funds are open-ended funds that invest in gold ETFs. They also allow Systematic Investment Plan (SIP mode of investment, which will let you to invest in small amounts and average your investments during price corrections," Kothari added

DETAILS OF GOLD BONDS

• Rs 3,146/ gm – Issue price of SGB
   
• Rs 3,096/gm – Price for online buyers
   
• 2.5% per annum – Interest rate offered on latest SGB tranche