The global economic crisis instigated by the sub-prime mortgage lending in the U.S. has led to many investors taking refuge under the precious yellow metal. Prices of the precious yellow metal have shown a resilient up-move ever since 2008, and even today while the global economy is recovering, many smart investors are preferring to take refuge under the precious yellow metal, thus safeguarding themselves against the backdrop of downbeat global economic events such as:

 

• Downgrade of U.S. sovereign rating from ‘AAA' to ‘AA+' with a negative outlook
• Debt overhang situation in the Euro zone
• Inflationary pressures in the Emerging Market Economies
   

Taking advantage of these positive sentiments, the Indian mutual fund industry is witnessing the launch of several "gold funds" right since February 2011 (despite the skyrocketing prices of the precious yellow metal), thereby trying to woo investors. But herein let's assess whether it is prudent to invest in the precious yellow metal at present.

Can gold get bolder?

Gold has been historically considered as an important asset class mainly for three reasons:

 

• It is a hedge against inflation
• It adds stability to the investment portfolio
• Asset Allocation avenue
   

And as an asset class, gold over the year has shown a secular uptrend. In 1971, the price of gold was about U.S. dollar 32 an ounce and today (mid-August 2011), gold has crossed U.S. dollar 1,800 an ounce mark. This indicates that price of gold has gone up by 56 times over the last 40 years. Even in the last 13 years (i.e. since Jan 2, 1998) as depicted in the chart hereunder, until August 22, 2011 gold prices have appreciated by whooping 559% (on an absolute basis).

 

Precious yellow metal shines!!

 

At present the House of Representatives have voted on August 2, 2011 for an increase in the U.S. debt ceiling limit by U.S. $2.1 trillion (making it U.S $16.4 trillion), and also agreed to cut federal spending by U.S. $2.4 trillion dollars or more. This in our opinion would purely bloat the U.S. economy (which already has been made a 92% increase in debt ceiling in the last 3 decades) and make its debt to GDP ratio daunting to manage.

 

Big fat U.S. debt ceiling

(Source: whitehouse.gov)

 

Moreover we believe while the debt ceiling limit is increased, the long-term risk of sovereign default crisis by the U.S. still remains because this decision of increasing debt ceiling limit is purely a case of postponing a sovereign default to happen. Moreover the dawdling pace of economic growth rate is not justifying the increase in debt ceiling limit, and high unemployment rate (9.10% in July 2011) remains a cause of concern.

The picture in Europe too narrates a gloomy story. With Greece's failure to put its public finances in place has caused a situation of a debt overhang in the Euro zone, and is also spreading a contagion to the other countries in the Euro zone.

In India, while the Reserve Bank of India (RBI) has maintained its anti-inflationary stance and increased policy rates 11 times successively since March 2010; the results haven't been too positive as the inflation bug continues to haunt and be over the comfort level (of 8.00%) of RBI (WPI inflation for July 2011 was 9.22%).

Thus taking a view of the aforementioned downbeat economic factors we are of the opinion that the northward trajectory for gold would be maintained as global economic recovery appears to be facing stumbling blocks. In fact being aware of the same most economies led by the U.S. and the Euro zone ones are maintaining elevated levels of gold reserves too (as revealed by the chart below), in order to hedge the risk of an economic breakdown. Moreover if the U.S. dollar weakens due to bloated debt to GDP ratio, the northward trajectory would be clearly paved for the precious yellow metal.

 

Heaping up gold

(Source: World Gold Council, PersonalFN Research)

 

Hence taking into account the fundamentals for gold presented above, we strongly believe that gold as an asset class makes a strong case for inclusion in one's portfolio (as it would insure / hedge your portfolio against the various risks it is exposed to).

But let's assess whether investing in gold through "SBI Gold Fund" (SGF) (a recent introduction to the product portfolio of SBI Mutual Fund) would be a prudent investment decision.

   

Positioning of the fund

It is important to note that SGF is not a gold ETF (Exchange Traded Fund) but in fact a Gold Fund of Fund (GFoF) which will invest in the parent scheme of the fund house i.e. in SBI Gold ETF. As per its offer document, the investment objective of the fund is "seek to provide returns of that closely correspond to the returns provided by SBI Gold Exchange Traded Scheme (SBI GETS)." SGF will in turn track the domestic prices of gold as SBI GETS tracks the domestic gold prices.

Thus being passively managed, SGF enables its investors to invest in gold through a paper form, thereby providing the convenience of Systematic Investment Plan (SIP) as well as lump sum investments, but without having its investors to open a demat account to avail its benefits (which is unlike Gold ETFs). Since SIP is a special feature of SGF, it provides the convenience and advantage of rupee-cost averaging and compounding to its investors. Also since holding a demat account is not necessary, investors would not have to incur charges such as annual maintenance charge for demat account, delivery brokerage charges, transaction charges (while investing in demat mode) etc; thus making it a cost effective investment proposition.

Moreover liquidity too is not restrained by the fund, as investors can subscribe and redeem units on all business days directly from the AMC (while purchase and sale of gold ETFs depends upon the liquidity on the exchange).

 

Portfolio & Investment Strategy

Portfolio of SGF will predominantly constitute of investments in SBI Gold Exchange Traded Scheme (SBI GETS), but not ruling out upto 5% allocation towards short term fixed deposits and other money market instruments.

 

Type of Instrument	% of Net Asset	Risk Profile
Units of SBI GETS	95% - 100%	Medium to High
Reverse repo and / or CBLO and / or short-term fixed deposits and / or Schemes which invests predominantly in money market securities or Liquid Schemes*	0% - 5%	Low to Medium

*The Fund Manager may invest in liquid schemes of SBI Mutual Fund. However, the Fund Manager may invest in any other scheme(s) of a mutual fund registered with SEBI, which invest predominantly in the money market securities
(Source: Scheme Information Document)

 

SBI GETS too which is the underlying fund, invests in physical gold which shall be of fineness (or purity) of 995 parts per 1000 (99.5%) or higher. Thus SGF being a feeder fund would be focused on providing returns that closely correspond to the returns provided by SBI GETS

 

Performance of the underlying fund - SBI GETS

So far as revealed by the chart below, SBI GETS has been closely tracking the price movement in physical gold before factoring in for the expenses.

The path so far

(Base: 10,000)
Note: Gold prices are of MCX gold
(Source: ACE MF, PersonalFN Research )

 

How Gold ETFs have fared

Gold Exchange Traded Funds	Absolute				CAGR		Tracking Error	Expense Ratio	% Holding in Gold	Holding in Cash
	1 Month	3 Months	6 Months	1 Year	2 years	3 Years
Gold BeES*	14.6	21.1	29.0	39.9	32.2	30.4	0.0535	1.00	99.98	0.02
HDFC Gold ETF	14.5	20.9	28.7	39.5	-	-	0.1419	1.00	99.11	0.89
Kotak GOLD ETF**	14.6	21.1	29.0	39.9	32.3	30.3	0.0536	1.00	100.02	-0.02
Reliance Gold ETF	14.6	21.1	29.0	40.0	32.3	29.9	0.0536	1.00	100.59	-0.59
Religare Gold ETF**	14.5	21.0	28.9	39.8	-	-	0.0536	1.00	100.33	-0.33
SBI Gold ETF	14.6	21.1	29.0	39.8	32.0	-	0.0535	1.06	100.00	0.00
UTI Gold ETF	14.6	21.1	29.0	39.9	32.3	30.3	0.0536	1.00	110.88	-10.88
Gold-India	15.6	22.2	29.5	41.3	33.9	32.6	-	-	-	-

*Portfolio as on June 30, 2011
**Portfolio as on March 31, 2011
For the rest of the schemes the portfolio is as on July 31, 2011 and the NAV data is as on August 18, 2011
(Source: ACE MF, PersonalFN Research )

 

Even when judged in comparison to its peers, the table above reveals that SBI GETS has delivered competitive returns across time frames and that too without much variation in the tracking error.

 

Taxation

On the taxation front too as per the present tax laws (Income Tax Act, 1961), investment in SGF would enable investors to avail the benefit of indexation on long-term capital gains after the period of one year of its holding. However, any sale of the fund before the period of 1 year would attract short-term capital gains tax.

It is noteworthy that at present for investment in physical gold, the benefit of long-term capital gains tax is available only after the completion of period 3 years of the asset's holding.

 

Fund Manager Profile

SGF will be managed by Mr. Raviprakash Sharma who is a Chartered Account (C.A.), a commerce graduate and also has to his credit a C.F.A. charter. Prior to joining SBI mutual fund, Mr. Sharma has worked with HDFC AMC, Citi group wealth advisors, Kotak securities, Times Investors Services and Birla Sun Life Securities. He has a total work experience of over 12 years including 10 years of experience in portfolio management services.

 

Our view and Fund Outlook

Taking into account the economic factors discussed above, gold prices are likely to maintain their upward trend. Yes, sure there would be phases of consolidation as stability in various economies comes in. But till long standing debt problems in the developed economies are not resolved optimally, gold will be one of the most sought after assets in the investment arena that will dominate the performance chart.

There are no two opinions about investing in gold. In our opinion SGF offers an attractive and valuable investment proposition to investors, as they can keep investing in this classic asset class without really having to physically hold gold and incur substantial holding cost (in the form of locker rents). Moreover, since SGF being positioned as gold FoF, (feeding SBI Gold ETF) which does not make it mandatory for investors to hold a demat account to buy gold; it furthermore makes it cost effective (as annual maintenance charges, brokerage fees and transaction costs for operating in demat mode are done away with). Also the SIP facility available in SGF, adds as an enticer for investors to invest in gold regularly in small amounts thereby leaving them with less hassles of timing the market and providing them with the advantage of rupee-cost averaging along with compounding. Also, the liquidity is not restrained by SGF, as investors can subscribe and redeem units all business days directly from the AMC.

Hence we affirm that SBI Gold Fund deems inclusion in one's portfolio.

 

This article was written exclusively for Equitymaster, India's leading Independent research initiative. Trusted by over a million members all over the world, Equitymaster is known for its well-researched, unbiased and honest opinions on the Indian Stock Market.

 

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sales@zrhv.cn Nov 03, 2011 In awe of that answer! Really cool!

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