Why gold bonds are better investments than gold ETFs
Only investors who can hold the bonds till maturity should consider buying them.
According to NSE, gold ETFs have gained up to 24% over the past year, with the average gold ETF gaining 21% during this period. Meanwhile, sovereign gold bonds listed on the exchange have delivered up to 31.2% returns, even as the average gain across all bonds stands at 26.2%. Clearly, SGBs have rewarded investors better than gold ETFs.
There are several reasons for this. Unlike gold ETFs, there is no expense ratio involved in holding SGBs. Gold ETFs charge anywhere between 0.35%-0.8% every year as expense ratio, which is deducted before arriving at the fund NAV. These expenses eat into the NAV of the ETFs and affect their ability to track gold prices. Besides, apart from investing in physical gold, these ETFs also have to keep a tiny portion of their corpus in cash or cash equivalents to maintain liquidity. This non-gold exposure adds to the price gap relative to actual gold. Also, since these ETFs are actively traded on the exchanges, prices often depend on the trading activity. As such, the price of gold ETF often differs from the underlying fund NAV.
However, there is another crucial reason for the higher returns from gold bonds. The price of sovereign gold bonds is directly linked to the prevailing price of gold of the highest purity—24 carat. But most SGBs typically tend to trade at a discount to the actual gold price owing to the low liquidity. While SGBs are tradeable on the exchanges, the volumes are very low, resulting in a price discount to physical gold. Lower the liquidity, higher is the discount.
Buyers can effectively purchase the gold bonds at a discount of up to 8-12%. However, the discount at which SGBS were trading at a year ago has narrowed, as a result of renewed interest in gold. While gold bonds were trading at a steep discount of around 13-15% a year back, this has fallen to around 7-9% for the most liquid bonds. The less traded bonds are available at a discount of 12-13%. Effectively, this narrowing of discount has also contributed to the higher return from gold bonds.
Gold bonds trading at a lower discount now
The volume of trading in the bonds is very low, leading to steep discounts.
Note: Above table includes only the most actively traded gold bonds. Source: NSE. Data as on 5 Aug
So does this mean SGBs are a better way to invest in gold? Experts point out that gold bonds do offer many benefits over gold ETFs. The bonds offer regular interest income to the investor—2.5% per annum payable half-yearly on the face value of the bond. Hemant Rustagi, CEO, Wiseinvest Advisors, points out, “It is the only vehicle that allows you to benefit from appreciation in gold price while also generating regular income for you.” Another major benefit over gold ETFs is that the capital gains on the bonds are fully tax exempt if held till maturity of eight years.
Meanwhile, any gains realised from gold ETFs after three years are taxed at 20% after indexing the purchase price for the corresponding inflation rate. However, gains realised from selling gold bonds on the exchanges before maturity are liable for taxation at the same rate as gold ETFs.
However, liquidity is an issue with gold bonds. As mentioned earlier, gold bonds are available at a discount owing to low liquidity. Even with the smaller discount, SGBs are worth considering over gold ETFs, but only by investors who can hold till maturity. Else, investors may be forced to sell at a discount when exiting prematurely. Amol Joshi, Founder, PlanRupee Investment Services, says gold bonds should strictly be a buy-and-hold investment. “Gold bonds are a good option only if you need gold exposure for a time horizon matching the tenure of the bonds.”
Chirag Mehta, Senior Fund Manager, Quantum AMC, feels liquidity in SGBs compares unfavourably with gold ETFs. “One can redeem gold bonds only after five years; they can be sold earlier in the secondary market but usually at a steep discount.” Besides, gains realised from selling gold bonds before maturity are fully taxable, like gold ETFs. The interest received on the bonds remains fully taxable. This is added to the taxable income of the individual and taxed at the applicable rate.
Also, keep in mind that sovereign gold bonds are not available on tap. The RBI launches fresh tranches of SGBs at regular intervals, during which individuals can apply for the bonds.
For investors looking to purchase SGBs anytime in between, the only way is to buy existing bonds already listed in the secondary market. SGBs allow one to invest in a minimum of 1 gram of gold, with the maximum limit of 4 kg annually for individuals. This annual ceiling will include bonds subscribed under different tranches during initial issuance by the government and those purchased from the secondary market.