The Mutual Fund Show: Should Investors Keep Adding Gold To Their Portfolio?

Here’s what financial advisor say over allocating a portion of your portfolio to the yellow metal.

A gold ingot. (Photographer: Andrey Rudakov/Bloomberg)
A gold ingot. (Photographer: Andrey Rudakov/Bloomberg)

Prices of gold, having surged nearly 30% through the first eight months of 2020, have moderated. Should investors continue to add precious metal to their portfolio?

Yes, says Suresh Sadagopan, founder of Ladder7 Financial Advisories. And he suggests sovereign gold bonds over mutual funds. Such bonds, he said in this week’s The Mutual Fund Show, are better due to their certainty of interest and tax-free returns if the investment horizon is for the full duration of eight years.

Avinash Luthria, financial planner and SEBI-registered investment adviser at Fiduciaries, disagreed. He said returns from gold are far more difficult to forecast than those from the stock markets, and that the metal’s price is yet to reach its inflation-adjusted peak from 1980.

On this week’s show, the two financial advisers also discussed the possibility of mutual funds coming under the ambit of tax collected at source (TCS) regime, and SEBI’s tighter norms on inter-scheme transfers in mutual funds and their impact on investors.

Watch the full show here:

Here are the edited excerpts from the interview:

A lot of questions are posted to me on Twitter and through other social media platforms that with equity markets having reached this 12,000 mark, people are thinking of how to buy a bit of protection as well. Are there other options because real estate is out of favour, and is gold giving a chance? I will request my guests to elaborate a bit on which form of mutual fund tool could be a good way to invest into. Suresh, I’ll start off with you.

Sadagopan: So, as far as an asset allocation is concerned, my view is that gold is a strategic asset and it has a different profile as compared to other assets. So to that extent, an allocation into gold is always suggested by financial advisers and I am no exception to that. Now, when gold was actually moving up significantly, a lot of people actually came into gold and if you were to look at in the last few months—the amount of money that has been put into gold ETFs has been rather significant and it has been rising. Now, since August there has been a kind of plateauing and fall in the gold prices and because of that again, there has been a rethink on the part of investors whether this is such a good idea or not and because of that, the flows have ebbed and probably in some cases, I also hear that there has been a withdrawal in terms of gold assets. So my larger point is that different assets are going to perform at different points and there can be multiple reasons for that. Gold is performing for all the reasons reasonably known to us already. So my point is, just because it has started falling, we really cannot assume that gold is not a good asset. In fact if you look at a 10-year time frame, gold has performed better than equity. I’m not saying that is a buying point in favour of gold, but I’m only saying that it’s a different asset class and we should consider buying this asset primarily in the form of a financial instrument. So that is what you wanted to know. ETFs are definitely a preferred financial instrument as far as gold goes, but my preferred financial instrument would be sovereign gold bonds simply because it tracks the price of gold and at the same time, Government of India is also going to give you something like 2.5% for every year you’re holding the bond. And one more very important attraction as far as sovereign gold bond goes, is that if it is held to maturity that is for a period of eight years, the whole proceeds is tax free. So, if you want to invest in gold probably sovereign gold bond is a good bet.

Suresh, what about gold funds? Should people use them or avoid them?

Sadagopan: Gold funds and gold bonds are actually two different things. Like DSP used to have a world gold fund, I think one or two other people have a world gold fund. So, this is basically tracking the performance of the company itself, not so much the gold. So if you want to invest in a gold mining company so that’s completely different from gold, while I do understand that gold prices will have an effect on the performance of the company. But gold mining companies, they have different dynamics as compared to the physical gold prices. So, if you really want to stick to gold as an asset class and if you want to only want to track the price of gold in reality, then I think you should stick with gold. If you want to be slightly more adventurous in the sense that you really want to also get riding on the company per se along with the price of gold, then I think a world gold fund kind of bet will be fine.

Avinash, do you have any thoughts on the same topic?

Luthria: Gold is a pretty hard asset to forecast. It’s even harder than equity. People tend to think of gold as a very safe asset but actually it’s a very tough asset to forecast. If you go back in history from 1980 when it was at its peak... from 1980 to 2001, it’s purchasing power fell by about 83%. So, it was a pretty significant fall. Even as of today, gold hasn’t yet reached the purchasing power that it was in 1980. You’d imagine that even 40 years later, it’s still not caught up with inflation and reached the purchasing power. So, it’s a very hard one to predict. I have personally never recommended gold to my clients for that reason. I will never not recommend it, but I never have recommended it. My stance is generally that if your issue is that you don’t trust the rupee and inflation in India, you are better off, I mean, you can’t buy safe assets in the U.S. but what you can buy is the U.S. S&P 500 index fund. That’s a better way to get exposure to a dollar asset, which is what people are trying to do with gold, without actually using gold. I know that’s risky, but still I think less risky than gold.

What we learned is that mutual funds and AIFs may come under the ambit of the new tax collected at source regime, effective Oct. 1. Any thoughts on this Suresh? How does this impact life?

Sadagopan: Yeah I mean, if this is a government fiat, there is not much we can do about it. But I’m just being thankful about this whole thing that it is only 0.1%. It could have been a much higher number there. So yeah, it does affect us, but I think we have to take the rough with the smooth and we have to move on in life. So, I have no specific comments on that.

Suresh, any way to assess the impact there?

Sadagopan: Suppose we take a Rs 1 lakh investment, the impact of that on one’s investment will be of something like Rs 100. So would I like to have that Rs 100 back from the government in my kitty? The answer is yes. But I mean the government will make rules and we will have to follow those rules and Rs 100 seems to be an easy enough way to get through and get on with life so if you look at it that way, I would say that, let us not fret too much on this. Let us look at how we can allocate our money appropriately and get returns and move ahead in life. So that is how I will look at it. So, there is nothing much we can do about it. The impact is actually pretty less. So I would not really dwell too much on that or worry too much on that.

Avinash, any different thoughts?

Luthria: I agree with Suresh on that. I mean it’s not an issue really, I’m not a CA, but I think let’s wait and see but it doesn’t move the needle for long-term investors.

Avinash, I’ll start off with you on this one, and that is this inter-scheme transfers. I think it started post Franklin, right? Where in one or two fund houses did those transfers. Now, with the move that is being done or thought of being done and I presume that it is now into effect as well, how does this alter the landscape, both from a fund perspective as well as from a perspective of somebody who is watching this, or has watched in the past and said hey why is this happening and now, is that kind of ring-fenced? Do you have any thoughts here?

Luthria: I see it in a big picture is SEBI trying to have a tighter governance and tighter control over everything. And I think in general that has been a positive step. This particular issue doesn’t really bother me too much or impact my clients and my kind of advice too much. I largely just recommend overnight funds and a few subset of liquid funds which hold mostly government treasuries. So for those products, it doesn’t matter. For the rest of the products, it could have some small impact, but generally should be a positive impact for people. I think to the extent that this is really bothering you in your portfolio then probably you have constructed a wrong portfolio if you have to worry about this issue really.

But a lot of times people are also have legacy things, and to be honest and until this happened with a couple of large fund houses, nobody quite thought of second guessing what the impact of this could be and which is why maybe there’s a lot of chatter around this. Suresh, do you want to dwell a bit on this?

Sadagopan: So, I would agree that this is a very good positive news from where the investor community is concerned. While the fund houses may have their reasons to transfer, one of them is to establish liquidity in a particular scheme. It can certainly affect other schemes and we have seen that it has affected other schemes as well, adversely. So the point is now if they are putting certain end conditions or if they are imposing certain conditions at what points they can transfer and in what conditions they can transfer, I think it is all for the best. So, I have gone through this and it looks to be a very good step from SEBI’s side in terms of protecting investors’ interests.

Anything from a mutual fund manager perspective, Suresh, that would be a bit cumbersome to manage because when an event happens you kind of paint everybody with the same brush, right? Because some funds won’t be able to do it or maybe some ones might be able to use this flexibility in a good fashion. Does that kind of reduce that or you think that is not necessarily the case, and again, I’m not talking about the two safest categories, which is overnight or the most liquid categories, but the other ones?

Sadagopan: I understand. So, SEBI is allowing inter-fund transfers primarily to tackle such liquidity situations which may arise at any point in time. They want to protect the investors’ interests in the sense to just show a good picture in one fund or meet the liquidity you should not penalise some other fund. So, that is what they are trying to do. So, if they are saying that you exhaust all other possibilities and then you look at this inter-fund transfer and it has to be transferred at an appropriate price. It cannot be that one fund is gaining something while the other fund is losing something. So, it cannot be like that and they have also ring-fenced this other issue that there is a negative news circulating or you feel through your internal credit mechanism that this particular paper should not be there so you just are dumping into some other fund, it is kind of obscure from the fund house perspective. So, those things are not any longer permissible and you cannot dump anything into a close-ended scheme also. So, these are very very good steps from SEBI’s side and I think any good fund manager probably anyway will not do all these things, but only that this has now become a law, they will have to definitely follow this law in letter and spirit.

Avinash, there is an argument that so many people make that let mutual funds and debt funds be a pass through vehicle and not necessarily an investment in debt fund being the vehicle to earn that 1% extra. There’s so many people who say that, “Why is it that the fund managers are taking undue risks?”. I’m not saying funds have done that or not done that, I’m saying the argument is that a lot of people are saying that why are fund managers taking this undue risk for that 1% more wherein all I want in my debt fund investment, primarily is for safety and then maybe if the extra return comes, great. So, do you think the whole spate of regulations that has come in ever since the Essel move happened back in 2018 are maybe making funds more true to label and the red category and maybe the option of making abnormally high returns via fund managers a lot less possible?

Luthria: I see debt mutual funds as a tax arbitrage mechanism for people in the high tax bracket. So, if you’re not 30% plus in the tax bracket, then pre-tax you will earn low returns on your fixed deposit but post-tax, you will earn higher returns on your fixed deposit, hopefully you can be sure. So that’s the right way to look at a debt fund as—keep your money safe and that’s how I look at it and from that point of view, I do not really want this extra yield on these debt funds. This could be my personal view and hence I don’t like credit risk funds, etc. And I think by and large most retail investors should be looking at it that way. And from that point of view, I wouldn’t comment about true to label but I think taking less risk is better for the debt funds.

Suresh, your thoughts here?

Sadagopan: I would kind of echo what Avinash has just now said. We are not really looking at debt funds, purely from the point of generating that 0.5% or 1% extra. While it is very much possible that a debt fund can potentially generate that 0.5% or 1% extra, as compared to what is typically available for a general investor because there are so many vehicles which are available to qualified institutional buyers like a mutual fund, which is generally not available in the public domain. So, there are possibilities of them actually striking a good deal with a good company and a well rated company and they can potentially earn that 0.5% or 1%. I do concur with what Avinash told some time back that even if it is more or less the same return or slightly a higher return, on a tax adjusted basis it is generally better than a typical comparable vehicle of a similar credit quality. So the most important thing I would say is that as compared to most other vehicles, this is absolutely liquid and you can be absolutely sure that you will get your money when you want the money. So, that is I think the most important thing when I’m actually looking to invest in debt mutual funds.