Add Some Shine To Your Portfolio

Add Some Shine To Your Portfolio

Every portfolio should hold various asset classes which at best should be inversely related or have very low correlation. The concept behind the same is to offer stability to the portfolio. While the main asset classes are equity and equity-related instruments, debt and money market instruments and real estate, among others, gold gives the portfolio the much required stability during any downturn

In India, it is a tradition for every family to possess at least some units of gold in the form of jewellery or investment. Love for gold jewellery is in fact ingrained in our culture. There are occasions when buying gold is considered auspicious in India. Gold is purchased in the form of coins, bullions or jewellery. They are in physical form. However, now individuals willing to invest in gold can purchase gold funds, gold exchange traded funds (ETFs) or sovereign gold bonds rather than investing in physical gold. Investment in gold offers liquidity, inflation-beating returns and is considered one of the safest asset classes. Evidently, gold prices are rising year on year along with inflation. The following graph depicts the trend of gold price since 1979.

As can be seen from the graph, there has been a surge in the price of gold over the decades. Thus, investment in gold is beneficial as the returns are in line with inflation. Moreover, investment in this yellow metal is considered to preserve and protect one’s wealth. Referring to the graph, if you had invested Rs1,000 in gold at the start of 1979, your wealth would have increased to Rs75,000 by now with an annualised return of 6 per cent. This is how investment in gold safeguards the capital of investors. Now, the question arises whether an investor should necessarily choose to invest in gold? Let’s look at the pros and cons in the following paragraphs.

Gold as an Asset Class

Initially, we looked at how gold prices have been rising which can deliver inflation-beating returns. However, should you consider investing in gold for diversifying your portfolio? The obvious answer is ‘yes’. A diversified portfolio should consist of asset classes which provide stability and constancy. A portfolio consisting of similar asset classes, which are directly or positively correlated, will not give you the desired results and will lead to severe downfall in case of any event that has a damaging impact on the assets you are holding. For instance, if your portfolio comprises all direct equity as well as equity-dedicated mutual funds then in case of a downturn in the market your portfolio as a whole will be affected.

In order to avoid such circumstances every portfolio should hold various asset classes which at best should be inversely related or have very low correlation. The concept behind the same is to offer stability in the portfolio. The main asset classes are equity and equity-related instruments, debt and money market instruments, gold and real estate, among others. Likewise, gold investment helps a portfolio to be stable as it is inversely related to the equity markets and acts as a cushion during any downturn of the markets. Asset correlation is important because the goal of asset allocation is to combine assets with low correlation. The purpose of asset allocation is to lower portfolio volatility.

By adding low correlation or negatively correlated investments in the portfolio, the overall volatility and risk of the portfolio is lowered. Asset correlation is measurement of the relationship of the movement between two or more assets. The correlation measurement is expressed as a number between +1 and -1. A +1 indicates positive correlation which always moves in the same direction and in the same proportion. A -1 indicates negative correlation which always moves in the opposite direction. Lastly, zero correlation indicates there is no relation between the assets. Gold has a very low correlation with equity. The best part is that as and when the equity market falls, gold starts performing well. The following graph depicts the average monthly returns between the Sensex and gold over the years.

Referring to the above graph it is evident that gold performs well when the Sensex falls. As is evident from the great financial crisis of the year 2008, when the market had crashed, gold performed well. The average monthly return of the Sensex in 2008 was -5.45 per cent while for gold it was 2.47 per cent. The average correlation between the monthly returns of gold and the Sensex is -0.00708. The following rolling yearly correlation between gold and the Sensex highlight the above fact. 

Let’s look at the relationship between gold and the Sensex for the year 2020.

In that year, the world was hit by the pandemic which affected the world’s economy. The equity market faced a huge drawdown. The economy was adversely affected due to a complete lockdown in the country. Referring to the graph we can see that during March the Sensex fell when the lockdown was implemented and that is when gold started perform-ing well. As can be seen, the trend is that gold performs well when the Sensex returns are either low or negative and gold underperforms when the Sensex recovers or starts performing well. The above analysis of gold as an asset class and its relationship with equity as another asset class has shown that it can be used to diversify your portfolio. There are different ways of investing in gold as explained in the first paragraph. Now let’s explore them in detail.

Investment Options in Gold
Investors have various options to invest in gold such as physical gold, gold mutual fund, sovereign gold bonds (SGB) and gold ETFs. We will take look at each of them in detail:

Physical Gold : Conventionally, Indians invest in physical gold. People buy gold not as an asset but for consumption purpose. Gold can be purchased in the form of jewellery, bullion, coins or biscuits. In India, people exchange gold during marriages or any other auspicious occasions. Nonetheless, physical gold has many drawbacks such as the need to store it in a safety vault or bank locker which adds up the cost, no flexibility in investment amount, purity issues, etc. Investors can circumvent these drawbacks by investing in gold mutual fund, gold ETFs or SGBs.

Gold Mutual Fund : Gold mutual funds are open-ended funds. These funds are one of the newest ways to invest in gold without actually holding it physically. The price of the fund is directly dependent on the price of gold. The fund manager invests in the stocks of companies mining gold or invests in gold ETFs, which in turn invest in physical gold of higher purity. Changes in gold’s global market prices can cause changes in the price of gold or funds investing in gold. These funds offer lower returns as compared to equity funds but deliver returns when a market falls.

Gold ETFs : Gold ETF is a transparent vehicle which provides an effective and efficient platform for small investors to diversify their portfolio into gold. Investing in gold ETF assures the purity of gold and offers liquidity. In order to invest in gold ETF, you need to have a dematerialisation account. The expenses incurred in buying and selling the gold ETFs are much lower than buying, selling, storing and insuring physical gold. As per the Association of Mutual Funds of India (AMFI), the asset under management (AUM) of gold ETF was Rs16,225 crore as of June 2021 and inflow in the month of June 2021 in gold ETF was Rs359.66 crore.

Sovereign Gold Bonds : SGBs are government securities denominated in grams of gold. They are a substitute for holding physical gold. Investors have to pay the issue price in cash and the bonds can be redeemed in cash on maturity. The bond is issued by the Reserve Bank of India on behalf of the Govern-ment of India. SGB is free from issues like making charges and purity as in the case of gold in jewellery form. The quantity of gold for which the investor pays is protected since he receives the ongoing market price at the time of redemption or prema-ture redemption.

Interest:
I) Interest on Gold Bonds will commence from the date of issue and shall commence from the date of issue and shall be paid at a fixed rate of 2.50% per annum on the nominal value of the bond.

II) The interest shall be payable in half-yearly rests and the last interest shall be payable along with the principal on maturity.

Conclusion
We know now how gold investment can help us diversify our portfolio and offer stability. However, investors shouldn’t allocate more than 5-10 per cent of the portfolio in gold. You should not expect gold to give you returns as equity does. Nevertheless, gold will help you to stabilise your overall portfolio returns. Before investing, individuals should assess their risk profile, investment horizon, goals and capital in order to decide the exact amount that should be allocated to gold. You may consider rebalancing your portfolio at least once a year. You could consider adding gold to your portfolio on a correction of gold prices if your portfolio lacks adequate allocation to this asset class. In case allocation towards gold is more than required, you should reduce the allocation. 

 

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