In November last year, the government launched Sovereign Gold Bonds (SGB's) amidst much fanfare. Much has been written since then on SGB's and their relative merits. This article aims to answer a simple question - when do SGB's make sense, and when do they not?
It's a known fact by now that we Indians have a preference for physical assets, the bulk of which is comprised of Real Estate and Gold. Personal preferences aside, it's vital to not go overboard into any asset class; which essentially means that it's not an 'or' decision to make between equities, gold, fixed income and real estate, but rather an 'and' and 'how much' decision!
First, know this: over the long run (five, ten, twenty years), Equities have a high chance of outperforming Gold as an asset class. History tells us that this outperformance could range from 3-5 per cent per annum - that is, unless you've been horribly unlucky in terms of timing your entries into the equity markets, in which case Gold may have actually outperformed stocks for you.
Over a twenty-year period, the SENSEX has outperformed gold by 4.5 per cent per annum, 2.6 per cent over a fifteen-year period and 4.1 per cent over a ten-year period. Mind you, a 3-5 per cent difference, compounded over a ten or twenty-year period is a lot more than it looks like. So lesson one, don't replace one asset class with another, but expose yourself to all asset classes in a well-planned manner.
SGB 101: they are issued at a ballpark rate equivalent to the price of 1 gram of gold. They mature in 8 years at the then prevailing price of gold. In the interim, you get a 2.75 per cent interest per annum. These bonds are tradeable on the exchange too.
Needless to say, SGB's trump holding physical gold. They are far more convenient and there's no risk of theft involved. If you need to convert your SGB's to physical gold, you could always sell them on an exchange and use the proceeds to buy gold.
The annual 2.75 per cent interest actually acts as an 'alpha' over traditional ETF's or gold savings funds, and so it's a no brainer that SGB's are better than ETF's for anyone who intends to hold onto their bond for the full duration of 8 years.
There are three cautionary points I'd like to make to investors when it comes to SGB's. First, market dynamics will ensure that their price increase will, in fact, lag behind ETF's; as the 2.75 per cent coupon will get priced into the security. A case in point: The Sovereign Gold Bonds 2.75 per cent NOV 2023 Tr-I has increased in price from Rs. 2684 to Rs. 3240 since November last year (a growth of 20.7 per cent). In the corresponding period, ETF's (such as SBI Gold ETF and Axis Gold ETF) have risen by 21.5 per cent. So for a shorter term investor who is subscribing to an SGB with the intent of selling out before maturity, it's likely that there will be little or no value add when compared to an ETF; the so called 'alpha' will cancel itself out.
Second, use SGB's judiciously as part of a carefully planned asset allocation. Especially when it comes to longer term financial goals such as your child's education, marriage or your retirement, equity SIP's are quite possibly a far superior instrument to consider.
Third, don't jump to invest into every issue. Gold prices have already gone up sharply in the past year Fact is, the first issue was priced at Rs. 2684 and the most recent one at Rs. 3150. Assuming that gold prices rise by 8 per cent per annum from the date of the first issue in November last year, the actual returns earned from the current issue (September 2016) will be 1.3 per cent per annum lower than the first one last year - a sizeable difference over a fairly long term holding period. Instead of subscribing to every issue, why not buy a fixed quantity from the exchanges every month? You'll end up averaging the cost of your entries that way.
In a nutshell, SGB's make sense for anyone intending to hold onto them for 8 years. Just don't use them to replace equities, and don't jump in to subscribe to each and every issue without adequate deliberation. And yes - if you're looking to trade, just stick with ETF's.
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