The Mutual Fund Show: Best Investment Options To Substitute Physical Gold
While for traditional gold lovers physical gold would seem to be the best option, it comes with its own challenges.
Indians’ love for gold is eternal, used not only as a wearable but also as a tool to tide over financial crises. And as a flight to safe havens amid the Covid-19 pandemic led to an eye-popping rally in the prices of the yellow metal, investors mull best ways to substitute physical gold.
While for traditional gold lovers physical gold would seem to be the best option, it comes with its own challenges such as a 3% goods and services tax and an inefficient price discovery method—the discrepancy in electronic ticker jewellers’ price, according to Vijai Mantri, co-founder and chief investment strategy at JRL Money. But if investors are comfortable of not having the physical commodity in their hands (or bank vaults), and are looking for flexibility and liquidity, investing into gold via exchange traded funds can be a good option, Mantri said on BloombergQuint’s special weekly series The Mutual Fund Show.
When someone buys gold in physical form, they buy a fixed quantity—like 1 gram, 2 grams, 5 grams, 10 grams at a regular frequency—and not a fixed amount, Mantri said. “When you buy a fixed quantity, you end up spending more money when the prices are higher and spend less money when the prices are low,” he said. But on equalising money, an investor can possibly buy more gold at lower price. That, Mantri said, is because the advantage of rupee-cost averaging is far more significant when invested through the mutual fund route such as ETFs.
Another option Mantri said is gold funds. That, instead of investing in the commodity, invests in gold mining companies or invests in funds that in turn invest in gold mining companies. This can generate exceptional returns if timed well, but can also erode the net asset values in times of a downside, according to Mantri.
In India, there are very few options of funds that invest in gold mining companies. One such, according to him, is the DSP Gold Fund. But it’s a good idea to enter into the DSP Gold Fund when returns are negative as the scope for upside improves once the cyclical upmove begins, he said.
ELSS Vs PPF
Equity-linked savings schemes, according to Mantri, are better than Public Provident Fund only for those investors who can survive some volatility to get extra returns.
Watch the full show here:
Here are the edited excerpts from the interview:
How would an Indian investor use the mutual fund route to buy into gold and whether it makes sense?
Mantri: It does make tremendous sense to invest in gold through the mutual fund route. Before I do that, let me give a background on how Indians have been investing in gold. One of their most favourite ways is to invest in jewellery and then coins and gold bars. Now, the challenge with physical gold is that we have close to 3% GST, and the price discovery is not very efficient. What price you see on various media, that is not the price at which you buy gold. So, there’s always an inefficient discovery of price when it comes to buying physical gold. Second option is sovereign gold bond. The third way to invest through financial assets. You can invest in gold using mutual fund as a tool. And this provides far greater flexibility in form of investing the kind of money somebody wants to invest, how much somebody wants to invest and also the flexibility to take money out at very short notice if anybody wants to do that.
Vijay, before we dwell fully into paper gold versus physical gold, I think liquidity becomes a key parameter?
Mantri: Yes, liquidity does become a key parameter. In the sovereign gold bond, you don’t have anything at least for the first five years. You can’t take money out and after five years, only in a six-month window you get the ability to exit. But whenever you exit there’s a capital gains tax incident at that time. So I think that is a challenge and though it is listed, I think in all these assets, trading volumes are not very significant. So you don’t get instant liquidity which you traditionally associate with gold or most financial assets. So, sovereign gold bond does provide 2.5% interest rate in the long term and capital gains are also tax free if you hold till maturity, but it does have its own sorts of challenges which cannot be avoided.
So now let’s dwell into investing into gold through mutual funds. What are the options? What is a better option?
Mantri: When someone buys gold in physical form, people buy a fixed quantity and not a fixed amount. And it is very important to understand ‘fixed quantity’ and a ‘fixed amount’. When you buy a fixed quantity, you end up spending more money when the prices are higher and you spend less money when the prices are low. For instance, if somebody is buying physical gold; invariably people will buy 1 gram, 2 grams, 5 grams, 10 grams, etc. at a regular frequency. So they spend not a fixed amount but they buy a fixed quantity of gold. If gold is Rs 4000 per 10 gram, they only spend about Rs 4,000. When the gold is at Rs 50,000, they end up spending Rs 50,000 for 10 grams of gold. But suppose you equalise that money, then perhaps at Rs 4000 you could have bought maybe 120 gram of gold at that time and at Rs 50,000 perhaps you’d just buy 10 gram. So, the advantage of rupee cost averaging is far significant, which only can be used through the mutual fund route.
Suppose somebody owns physical gold and bought 10 grams every month for last 10-12 months till June 30, then somebody’s spending close to Rs 4,81,000 and the value of that money is close to Rs 5,86,000 with an IRR of 45%. If somebody has done the same thing for three years, then would spend Rs 12,00,000.
Look at 10 grams gold number, for one year if somebody bought physical gold, then IRR is 44.79%, if somebody bought physical gold for three years 10 grams per month, then the IRR is 27.68%, and if somebody has done for a seven years, then the IRR is just below 14%.
If somebody who has a UTI Gold ETF—one of the oldest gold ETFs in the country—then for one year the IRR is 42.84%, for three years it is around 26%, and for seven years, it is just below 13%.
For physical gold, after one year, your value would’ve been Rs 5,86,440, but in gold ETF, the value would have been around a Rs 100 more. Though the IRR looks a little lower, around 2%, but in absolute value, it is absolutely equal. If you look at a seven-year period, the IRR in gold ETF is around 13.94%, but the total value is Rs 41 lakh and in the gold ETF, the same amount would have grown to Rs 46 lakh. So there’s Rs 5 lakh more that the investor has made in gold ETF because you are buying a fixed amount and not a fixed quantity.
The average cost of buying a fixed amount (of physical gold) is always lesser than the average costs in case of fixed quantity.
But Vijay, I could very well buy a fixed amount of physical gold as well, right? I mean yes, people usually buy a fixed quantity, but I can buy them right?
Mantri: It is impossible to buy a fixed amount of gold because how are you going to go and tell a jeweller I want to buy a bar or jewellery worth something?
Don’t they say there is this thing called cadbury wherein you get small amounts?
So, that is a fixed quantity — 1 gram, 2 grams, 5 grams, 10 grams and then 100 grams — that is cadbury. But it is a fixed quantity. This is for viewers to understand why SIP always creates wonders, because in SIP you are buying through a fixed amount. The average costs in fixed amounts are always lesser than average costs through fixed quantity. You could look at any other asset category. Be it gold, be it equity mutual fund, or be it debt mutual fund.
Vijay, what intrigued me was what you were saying that there is a better way to invest in gold by other non-physical routes. I thought ETFs was it, what else?
Mantri: So, if the gold does very well, then the gold mining company does much better. If the gold does badly in the world, then the mining company does much worse.
If you compare physical gold and gold ETF and just put the world gold of DSP—there are only two products available in the Indian context but it is the longest fund in the country. If you look at this fund, the IRR compared to physical gold or gold ETF it is 30% more for a one-year period. For a three-year period, the IRR is 7-8% more, and for a seven-year period, the IRR is 1% more.
Let me give an absolute number. In one year’s time, compared to physical gold in DSP World Gold, you have made around Rs 70,000-80,000 more. In a three-year period you would have made around Rs 2,00,000 more and in a seven-year period compared to physical gold, you would have made Rs 8,00,000-9,00,000 more. It is a far better alternative to go for owning gold. But keep in mind that this fund has always remained more volatile than gold itself. So if you have very positive views about gold then go for DSP World Gold Fund. Suppose you’re negative about gold then don’t touch it. You should invest mostly when this fund delivers deep negative returns. Then you’re going to make fabulous money because ultimately gold prices do recover. In the Indian context, I am tracking gold prices from 1925. I have a chart which explains that gold as an absolute term has delivered close to 8% CAGR for 95 years. So from 1925 till 2020 gold has delivered above 8% CAGR for almost 95 years—that is a staggering number. But please keep in mind, there has been a period where for a five-year, seven-year and for 10 year, and even 20-year period, in the Indian context, gold has not delivered returns. So when you are buying gold by just looking at their current, recent performance, also keep in mind that after a sharp rise in the prices, there comes a period where the gold price has not moved.
Vijay, the second part of the conversation—in the last two months people have taken money out, which is why this whole idea of trying to compare the safest product in the minds of investors versus an equity product which has got some equal characteristics. Take us through it.
Mantri: So, equity as we know is very volatile asset category and one of my very nice friends told me that 30% of the gains accrue the people who go through the volatility. So, this is what happens in equity. When returns are negative, people take money out but when the returns are positive, people invest more money. So what I’ve done here is a very simple thing. We have compared PPF versus ELSS. People invest in PPF for a 15 year period plus. So what we have done is that, we assume that an investor has invested Rs 1,50,000 per year on the April 1 of every financial year for the last 15 years or the last 20 years. So, for a 15-year period, the investor has invested 15 multiplied by Rs 1.5 lakh; about Rs 22,50,000 in PPF. The value of that is around Rs 44 lakh. If somebody has invested the same amount of money for 20 years, then somebody has invested Rs 30 lakh.
Now we will compare these numbers. Suppose you invest the same Rs 1,50,000 every year in form of SIP of Rs 12,500 for the last 15 years and 20 years, what has been the investment performance? So, first we took SIP in the worst-performing ELSS fund. For a 15-year, instead of Rs 44,70,000 plus in PPF, the value of SIP in the worst-performing fund is around Rs 42 lakh. But for a 20-year period, even in the worst-performing fund, the money is Rs 88 lakh in SIP compared to Rs 76 lakh in PPF. So, even the worst performing ELSS has outperformed the PPF over a 20-year period.
Then we looked at the SIP number in the average-performing mutual fund of ELSS scheme and the best-performing ELSS. So, an average-performing ELSS for a 15-year period, instead of around Rs 44 lakh plus amount in public provident fund, the amount which has accrued to the investor or accumulated in average performing ELSS is around Rs 48 lakh and the best-performing is around Rs 52 lakh. But just look at the 20-year number. Instead of Rs 76 lakh in PPF, the amount which the investor was able to accumulate in the average-performing and the best-performing ELSS is 2.5-3 times.
Yes, equity is a volatile asset category and PPF is very predictable, is very comforting. But if you’re able to withstand the volatility and can invest for the long term, the kind of money ELSS has generated, the difference is not in percentile, but in multiples.
Vijay, the past performance has not been an indication of what the future will do but can we safely say that averages still tell you a story?
Mantri: That’s very true, and one of the biggest challenges with PPF is that when the interest rate gets reset, it gets reset your entire accumulated amount. So maybe 20 years ago, the PPF interest rate was 12%, but when the interest rate comes down, the accumulation happens on the lower interest rate on the entire thing. But suppose you have done the same thing in a G-Sec fund, when the interest rate comes down, you get gains in G-Sec funds. Now, look at the 20-year CAGR of G-Sec funds in India, it is close to 10% and PPF is a claim on the government so it’s the Government of India security. Now, what we have seen that PPF rates are now linked to the G-Sec rates. Now, 10 years G-Sec right now is 5.80 basis points. Now, you will not be surprised if the PPF rate comes down to 6.5% or 6.25% in maybe three months or six months or maybe one year—it should have been done now but I think because of some political reasons, the government may not be doing it. But yes, on all contractual government savings scheme, the interest rate and return trajectory is absolutely downward.
Vijay, let’s assume that people are convinced that ELSS funds are a better way to invest into the tax saving of Rs 1,50,000 than a PPF. What kind of funds that can they go into because there’s a plethora of funds available? Again, past performance may not be the true measure of what will happen in the future, but you’ve analysed so many funds over such a long time. Which are the ones that have done really well over a long time? And again, what you’d say need not mean that the others are bad. I’m just trying to figure out what you think has done exceptionally well; not just in terms of returns but also in terms of stability of performance, etc.?
Mantri: So there are many funds in the market and one should not take a fund of what we are saying immediately because one also needs to see whether the similar kind of fund is there in the customer portfolio in the large-cap or small-cap and other category as well. So, don’t take my advice, as the fitment into your financial plan because you need to consult your own financial advisor. So we look at Mirae Tax Saver—that has done well. Also, Invesco has done well, ICICI Prudential has done well, Franklin Templeton now, the performance is under pressure but over a long period of time has done well. SBI funds have done well, Birla funds have well and also L&T fund has done well. There are at least eight to nine funds which have delivered a very decent investment performance over a longer period of time. But as you rightly mentioned, PPF is a very straight line, ELSS is not a very straight line. So, I will give a simple illustration. So, if you invested Rs 1.5 lakh in PPF and look at the performance after one year, the trajectory is always upwards. So, Rs 1,50,000 might become Rs 1,60,000—whatever the number.
In the worst case scenario, the ELSS number has come down from Rs 1,50,000 to Rs 75,000 and below. For a three-year period, I have examined the performance. In a three-year period Rs 4,50,000 invested in PPF has become say Rs 5,50,000 for argument’s sake. In this ELSS, the same Rs 4,50,000 even after three years is just below Rs 4 lakh or maybe Rs 3,50,000. So you have seen the PPF and ELSS gap over a three-year period. In the ELSS after three years, in the worst case scenario, the money is Rs 2 lakh lower than PPF and you get worried whether what hell have I done. So, when you do this path, this will happen. The ELSS for a three-five-year period will underperform PPF to the extent of Rs 2-3 lakh, but we are not talking about the Rs 2-3 lakh gap. If you look at the historic performance, we are talking about the gap of Rs 1.5 crore. The audience needs to understand that with little bit of volatility of Rs 3-4 lakh, maybe Rs 5 lakh over a five-seven-year period—the longer time period and gap is really stretched, so keep that in mind.
Anything else Vijay that I missed out asking you on this comparison?
Mantri: I think I just did a comparison for 20 years, but suppose you take the data for 23-24 years, then the numbers are really striking. I am tempted to tell the numbers. So, I did a study one year back, but I could not update that number and because of the lockdown my team is not coming to office regularly. There is one particular fund which was launched in 1996. The total amount in PPF for Rs 34 lakh has become say Rs 1.6 crore. In that fund, the SIP numbers of 24 years, the same amount invested, the number is close to Rs 10 crore.
Just keep in mind that PPF provides stability, mental peace, while equity can create some volatility in the portfolio. If you’re not comfortable with that kind of volatility over one-three years or even five-year period, then PPF is a better option. If you’re comfortable with the volatility, then nothing can beat ELSS in tax-saving products.