The Mutual Fund Show: Gold Bonds, Gold Funds Or Gold ETFs — Which Is A Better Investment Option?

Suresh Sadagopan: As a general rule, we have not been recommending small caps at all. People who have a fairly aggressive risk profile, we do recommend mid caps. As far as small cap participation, I prefer through multi caps. So that is what we are doing. Really aggressive clients who have a long horizon of earnings, we will probably give an exposure through mid caps and maybe multi caps. We are really very careful about small caps.

Vishal Doshi: I have just started recommending small caps to my clients because there is a lot of decimation in their net asset values and the prices of the stocks have also gone down significantly. I think some incremental allocation can be done to small caps but with a view of at least five to seven years.

Sadagopan: One of the things they are saying now is that whatever underlying investments are there in a liquid fund, they want to mark it to market. When there is a credit, what happens is, you immediately know what the price of that underlying investment is and it will reflect in the NAV. In the previous regime what used to happen is up to 60-days papers they used to amortise. So, whatever was the present price and whatever is the future price for the entire period they would amortise the rates. So, the exact price will not be reflected. So, the change which they have made currently is a good change and it will actually reflect the true value of the underlying securities and it can become slightly more volatile but it will also be a true reflection of what is the underlying investment value. That is point number one.

The second thing is that they are asking them to keep about 20 percent in liquid or near liquid instruments. That means that, even in a situation where there is a credit event there is enough liquidity in the system, which is a very positive step. This can have an impact in terms of returns. Returns can slightly go down but again, you are not investing in a liquid fund basically to make huge returns. What you are really truly interested is that the security should be, the amount that you are putting in, that has to be safe. So that’s the primary outlook.

Doshi: I think as of now many liquid funds are already holding 20 percent in near liquid assets. So, that may not be such a big impact. But the main point is this kind of regulatory changes are going to make liquid funds much safer. Plus, it is going to reflect the true picture of the scheme portfolio. So, the comparison between various liquid funds will now become easier—that is the real thing. These regulatory changes should be welcomed by investors because it is in their safety.

Sadagopan: I am quite happy with that. I only said there can be an impact on the returns. But I think in the overall scheme of things, from the investor point of view, that’s a welcome position.

Doshi: There are two sets of investors—conservative and aggressive. As you rightly pointed out, aggressive investors can look at credit risk funds. Last time I had mentioned on the show that the difference between the repo rate and the YTMs (yield to maturity) of these approval funds is now is very large and credit risk funds have now become attractive for aggressive investors. The people who understand the risk that is there in these funds, they can start looking at such funds. But investors who are conservative, who are not willing to take risks, they should stay with the liquids and ultra-short terms of this world. They should not venture into such kind of funds.

Doshi: No. But then equities are a different asset class and the risk profile is completely different. So, I don’t think both of them would be comparable. Because in equities you are there for multi-year investments. In credit-risk funds we are there for probably double-digit kind of returns, which is what the YTMs are offering right now. So, I think aggressive investors or investors with a high-risk profile can look at this.

Sadagopan: No. I have no point of difference. The only thing is whether it is DHFL or Essel or Reliance, it is not only the credit risk funds which are having those papers. I mean, these papers are present across the board in funds which are supposedly good funds. DHFL at one point of time was a AAA-rated entity. So, you would find it across the board. There is a bit of trepidation among investors with what would happen to my debt fund. So that concern is there. So, a lot of people have also told me that probably we should’ve invested in a simple bank fixed deposit. Maybe, from a return point of view, it may be somewhat less, but I will not have these kinds of palpitations at every point. When these people are doing their best and they are paying back something, there is some expectation that things will get sorted out now. People are waiting on the sidelines. As far as we are concerned, we are telling the investors that yes, it will take some time for the entire thing to blow over, but they are doing their best to sort out the problem.

Sadagopan: I would be cautious on this. Because these people are doing their best. I entirely appreciate that whether it is Essel or DHFL, I believe they are doing their best but the crisis in my opinion is slightly deep and slightly beyond the promoter’s level. It is structural—there are deep problems. How the exact problem will unfold in future, we don’t know. We really don’t know. I am cautiously optimistic that these people are doing their best. I wouldn’t go for credit risk funds in those kinds of things. We never went for credit risk funds in the last four to five years.

Sadagopan: We are still not going for it. We are going for safety.

Doshi: I am looking at ICICI Credit Fund. The portfolio there comprises AA and A security so obviously, it has that kind of risk. So, investors who understand risks with such rated papers, they should go in with this.

Sadagopan: As far as the CPSE space is concerned, I think it is a pretty diverse area. You have companies from defence to power to oil sectors. So, it can be any of those companies which are ultimately going to be dis-invested as per the government’s intention and mandate. So, which sectors will do well, which of those companies and sectors the fund manager will ultimately want to have in that portfolio, is a matter which is left to that fund manager to decide. The government has its reasons to liquidate. So, they have this mandate of liquidating more than one lakh crore in this year. From their point of view, CPSE is a good idea. At this point in time, markets are not doing well, and they also don’t want this crowding to happen. At this point, there is a re-think on that. But, purely from a mutual fund perspective, they will be looking at it not from the government company or a private company. I think they’ll be purely looking at merits and if the companies score on merit, they will look at it. Otherwise, they will not look at it at all.

Doshi: There are really not many funds which focused on PSU stocks as such. So, the government vehicle is CPSE ETF and probably the Bharat 22 ETF and that has some private names in it. Pure-play PSU investment is only the CPSE ETF. If you think from the government’s perspective up till now they have been continuously selling their stakes via the CPSE ETF route, but that is actually putting a lot of pressure on these stocks and you know it is, in the end the investors wealth is getting eroded by this method. Ideally, they should be going for strategic stake sales. Finally, now, they have said they have identified some 16 companies, where they want to do this. Even if you look at the history also, the last time when government did strategic stake sales was probably 1999-2004 period when quite a few names like BSNL, IPCL even Hindustan Zinc was getting sold to private players. The kind of wealth some of these stocks have made for investors have been very good. The stake sales happened when the market cap for Hindustan Zinc was just Rs 1,700 crore. Right now, it is around Rs 90,000 crore. So, investors who stayed on with it were clearly benefited but with the case of IPCL, which is now not listed, but when the stake sale happened it happened at a significant premium to the prevailing market price. I think price was around Rs 100 at that point in time and stake sale happened at Rs 230. So, the government really have huge premium on the prevailing market price and probably that is the right way to sale these stakes. So, let’s hope the government starts thinking on those lines.

Doshi: I don’t think so. I think whenever a fund manager exit happens investors have to ask a couple of questions whether they should stop SIPs or whether they should stop doing incremental investment in those schemes or whether they should pull out the existing money. Clearly the second option is out of table and therefore they should not do any kind of knee-jerk reaction so investors can probably then see how the new fund manager is, what is his pedigree and how many years of experience he has. Clearly, in case of UTI, the new fund manager Ankit Agarwal has got many years of experience with him. Previously, he was the fund manager with Centrum Broking PMS. In fact, he was ranked number one in Asia Money polls as the best fund manager in discretionary PMS space, so he has got some pedigree with him. So, investors should not behave in a knee-jerk kind of reaction and stop investing in such schemes where the fund managers exit have happened. So, we can look at others where fund managers exit has happened in the past like IDFC, Axis and DSP. All of these fund houses have seen a change in the top management in the fund management space. So, there have been mixed results, but you know just to immediately react and stop making incremental investments is not a right way for investors.

Sadagopan: Largely I concur with his views. What has happened regarding various fund houses when the fund manager changed, there are mixed results. One of the learnings as far as the fund houses are concerned is that now many of the fund houses have put up a robust process around this. It is not one superstar fund manager and he does what he wants or he/she does what they want. So, it is no longer the case and there is a process around it and there is analysts’ team around it. They have a meeting of what candidate should go in, they have a clear cut process of when they should exit, at what point, when they hit what numbers they should exit. So, those things are there and so in lot of cases fund manager exit itself may not be such a significant event, they have made it that way. I believe many of the fund houses are following that path and for that reason one should not worry. All the things which Vishal have said are valid. You have to look at the fund manager, the pedigree, the fund manager does make a difference, but I think it is not something which one has to worry so much. In fact fund house also have this thing of following the objective of the fund and the processes. If they are doing that then there is not much to worry.

Sadagopan: What I have heard some of the fund houses say, Sundaram has been talking about having a process and it is not a fund manager-centric thing. It is always a process that they have. So, similarly some of the other fund houses have very clearly explicitly set in processes. That’s a source of comfort for advisers like us because if it is going to be fund manager-driven, I mean you never know when the fund manager will exit. It is going to be a source of worry all the time. Fund houses have learned this, and I think many of them have put that process in place. We should not worry too much on that, of course at the same time look at who is the person that is taking over and till the time that person puts in some amount of time in the fund—keep monitoring.

Sadagopan: If I were to say the best way today will be the sovereign gold bond. The reason today for the sovereign gold bond is that the cost is negligible, you have to hold it for eight years, at the end of it there is no capital gain. Every year that you are holding that particular sovereign gold bond, you are also going to get two-and-a-half percent return. So, on one hand there is no capital gain, you are going to track the price of the gold and you are also going to get two-and-a-half percent return over and above that. So, in my opinion as compared to index funds, ETF’s or any other instrument today, I think that gives the best bank for the buck.

Sadagopan: As far as mutual funds are concerned you definitely have a gold ETF and a gold index fund wrapped around that. In case of gold ETF, it does track the price of gold, but you don’t have to hold physical gold, that’s the good part. But in case of an ETF, there is always a bit of tracking error. If you compare that with sovereign gold bond, you are going to get 2.5 percent more and there is no capital gain at the end of the tenure. So, now if you look at the index fund there are clear negatives as far as ETF’s are concerned—you will have to have a demat account, you have to sell and buy gold on the exchange. So, you may not probably able to do the SIP the way you would normally do in a mutual fund, so that is why gold index fund is also there which is basically investing into gold ETF. There the counter-party is mutual fund so liquidity is assured. So, in the case of ETF one cannot say that. So, here the liquidity is assured and here you can start SIP of whatever amount you want. But the negative point is that it is wrapped around ETF , so the ETF charges will be there and something will be there over and above that. So, as compared to sovereign gold bond this is not such a great option but for people who are already doing mutual fund investment and they don’t want to get into some other instrument and they want to keep it pretty simple, I think I will recommend index fund.

Doshi: Actually, I think there are three options as he rightly pointed out, one is the sovereign gold bond which the government has been issuing and I think that is a good option and all the three options have some or the other issues and some advantages with them. Sovereign gold bonds are good because obviously they are government-backed as they give you two-and-a-half percent interest rate and plus there is no capital gains, these are the good points. On the other side, liquidity is the problem otherwise, you can go to gold ETFs. Gold ETF’s provide some liquidity but the issue is there are some two-three charges which you have to bear for which is expense ratio and the second is some demat charges and the brokerage and you might have to open demat account, etc, to manage all of those things but then it also offers you liquidity. I think gold has added 20-21 percent in the last six months. So, gold ETF’s have nearly tracked those kind of returns and they have given the gold returns to the investors, but the gold funds have actually lagged behind, so I think there is gap of around 3-4 percent.

Doshi: I am not so sure. May be because of the expense ratio. As Suresh rightly pointed out, the expense ratio increases in a gold fund. So, these are the same houses offering gold ETF’s as well as gold funds, the difference is 3-4 percent. If you want to do the SIP’s then gold funds are better options. They give you that kind of facilities which are not available in the sovereign gold bond as well as the gold ETF option.

Sadagopan: The one that we are talking about are clear-cut investments in gold. There are some gold mining funds but that’s a different category altogether.

Doshi: There are some natural resources funds as well where gold is a part of those funds and there are some specific gold mining funds also but then that is a different way altogether.