Mutual Funds

Fund Query: Do sovereign gold bonds score over ETFs?

Aarati Krishnan | Updated on August 28, 2021

I have been a long-time investor into Gold BeES even before Sovereign Gold Bonds were launched. Earlier, gold ETF prices seemed to align with domestic gold prices, but in recent times they have been diverging. The current price for my gold ETF is about ₹41 when the gold price is ₹47. Am I now stuck in this ETF at a low price? In the world of SGBs, how attractive are Gold BeES anymore? Should we avoid investing into ETFs now?

Devendra Narkhede

Gold ETF prices could diverge from the gold rates you observe in the domestic market for four reasons. One, gold ETFs charge an annual expense ratio on their NAVs towards fund management fees and cost of operation. Over time, this expense ratio leads to the NAV lagging underlying gold prices. Nippon India Gold Bees’ current expense ratio is at 0.82 per cent per annum and this, over time, is the biggest factor leading to a lag in gold ETF returns vis a vis gold price returns. If you assess the 5-year return on the scheme, it is at about 7.2 per cent versus about 8 per cent on domestic gold prices.

Two, gold ETFs do hold some amount of their assets in cash and debt instruments to meet redemption demands and this too can result in a lag against pure gold returns. Gold Bees holds about 1.3 per cent of its assets in non-gold instruments.

Three, gold ETFs in India base their NAVs on the landed price of gold as traded in the LBMA at the prevailing exchange rate. Domestic gold prices can diverge from this translated price, leading to some discounts or premiums on ETF NAVs against domestic gold rates.

Four, there can also be a difference between ETF NAVs and their traded prices in the market. ETF prices can move into a premium or fall into a discount to NAV due to demand-supply factors. Over the long run, all these factors can add up to some lag (about 1 per cent) between gold price returns and ETF returns.

Sovereign Gold Bonds do carry distinct advantages over gold ETFs for investors because they don’t charge expense ratio, in fact, pay you an interest on the initial bond value. Their returns must therefore track gold prices more closely than ETFs. Theoretically, SGBs must deliver higher returns than ETFs in comparable periods. SGB returns are also exempt from capital gains tax if held to maturity.

However, in practice, SGBs are not all that liquid and owing to this, their traded prices in the secondary market also diverge from their underlying value. They are also not easily acquired or saleable through secondary markets. Investors who like to time their entry and exit from gold or those who like to invest equal instalments thus prefer gold ETFs over SGBs.

I am 60 and retired recently. I have an accumulation of ₹50 lakh in my EPF account. Is it advisable to continue keeping this amount in PF account which fetches me an interest of 8.5 per cent tax-free? Or is it better to withdraw this amount and invest in debt funds, which are likely to fetch higher returns than the above, which I may need on monthly basis? I am moderately risk averse.

Murali Manohar

As you have already completed retirement age and are at 60, your EPF balance will continue to earn interest only for three more years. Changes to the EPF rules a few years ago have made it possible for interest to be credited to EPF accounts for three years after the employee stops making contributions to it. However, rulings by the tax tribunal also make the interest on EPF balances taxable once the employee quits employment. Therefore, you need to compare returns on EPF after taxes to alternative avenues.

As to where you can re-invest this amount for regular income, you can consider government-backed options such as the Post Office Senior Citizens Savings Scheme, LIC’s PM Vaya Vandana Yojana and GOI Floating Rate Savings Bonds, as they have higher return potential than debt mutual funds and offer superior capital safety too.

Given the low levels of interest rates prevailing in the economy and the likelihood that they will rise from here, debt mutual fund’s returns over the next three years are unlikely to match their returns in the last three years. The key advantage that debt funds may offer over government options, though, is your ability to pull out the money anytime and pay a lower rate of capital gains tax on your returns, indexed for inflation, instead of taxes at your slab rate. We suggest you explore government schemes first and park residual amounts in debt funds for these benefits.

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Published on August 28, 2021

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