Traditionally, investors have embraced gold as a safe haven for portfolio protection during political tensions, geopolitical turmoil and economic turbulence. Gold prices, historically, tend to surge significantly only during periods of negative real interest rates when gold reclaims its traditional role as store of wealth that would at least keep pace with inflation to preserve the purchasing power of the investment. Bonds have a committed return, in the form of coupon / interest, which would result in real positive returns most of the times, or sometimes a loss, depending on movement of interest rates.
Gold has served as a strategic asset which acts as an effective portfolio diversifier and aids in improving risk adjusted returns while adding liquidity during periods of crisis without side effects of impact cost or difficulties in timing the market (Chart-1). As per analysis of world gold council on the hypothetical portfolio based on Willis Towers Watson Global Pension Assets Study 2019 and Global Alternatives Survey 2017, allocation of 2.5-10 per cent investment in gold provides an optimum hedge over the long run while considering returns, portfolio volatility, risk adjusted returns and portfolio drawdown.
Gold has historically protected investors against extreme inflation. In years when inflation in India was higher than 6 per cent gold’s price increased 11.5 per cent on average (Chart-2). Further, research by Oxford Economics shows that gold should do well in periods of deflation as well. Such periods are characterised by low interest rates and high financial stress, all of which tend to foster demand for gold.
Gold as an asset class
There is an opportunity cost of holding gold as unlike bonds or equities, gold doesn’t pay any interest or dividend. Gold’s effectiveness as a hedge may help the risks associated with portfolio volatility and thereby help in improving risk adjusted return.
Looking back almost half a century, the price of gold has increased by an average 14.1 per cent per year since 1973. Gold’s long term return has been higher than Indian stocks and higher than Indian government bonds, also outperforming other major asset classes
Methods of investment
Investment in gold can be done through physical gold, digital gold, sovereign gold bond, Gold ETFs or multi-asset funds. Every mode of investing in gold has different benefits and the choice depends upon the investor’s time horizon and other requirements.
Debt as an asset class
The asset category of bond mutual funds provides an excellent avenue for retail investors to participate and benefit from stable returns and portfolio diversification. Mutual funds are favoured globally with the variety of investment options that they offer right from liquid, ultra-short term to long-tenure. Debt mutual funds invest in fixed income securities like corporate bonds, government securities, treasury bills, bank certificate of deposit, commercial papers.
Over a period of 18 years, short-term debt funds have generated a CAGR of 7.54 per cent whereas gilt funds generated a higher CAGR of 8.18 per cent. Over this period gold generated a CAGR of 12.58 per cent.
Balanced allocation to equities, bonds, and gold and other commodities is important for better risk adjusted returns across good and bad times in markets. Allocation of 10-15 per cent to gold and the balance to the staple asset classes of equity and debt as per risk appetite and horizon of the investor can significantly improve risk adjusted returns.
There is an accrual in the portfolio or bonds carry a coupon, which accrues proportionately to the returns every day. Market based returns are over and above the accrual. Hence, there is a better degree of stability in debt mutual funds. For comparison with debt MFs, the nearest comparison is gilt funds, as it does not carry any credit risk and market-linked volatility is higher than other debt fund categories.
To be noted:
(a) The sanguine returns from gold includes rupee depreciation. For Indian investors, the global appreciation of gold prices is augmented as the landed or imported cost of gold is relevant
(b) we are doing the comparison after the significant up-move in gold prices due to global uncertainties.
For the investor, it is better to take a portfolio allocation approach, which would optimise risk-adjusted returns.
Looking at the latest returns from gold, one would be tempted to allocate higher. However, the current bull run would continue till uncertainties persist.