Gold bonds may make a dent in assets of ETFs

Effective return higher in gold bond, but liquidity could be an issue

The launch of sovereign gold bonds might not be good news for the gold exchange-traded fund (ETF) schemes of the mutual fund sector.

Gold ETFs are passive investment instruments, based on gold prices and investing in bullion. Each unit of the ETF is equivalent to a gramme of gold.

Market participants expect the assets under management (AUM) of gold ETFs to halve over the next six months, to about Rs 3,000 crore from the current Rs 6,000 crore. Till end-October, gold ETFs have seen 29 straight months of outflow, with the category AUM declining by more than half, primarily due to strengthening of the dollar and, owing to import restrictions, less demand for gold in the domestic market.

The big advantage of a gold bond is that it offers 2.75 per cent annually on the initial investment, payable every six months. Also, unlike gold ETFs, which charge management fees of up to one per cent, gold bonds charge none.

“Gold funds clearly score over gold ETFs and if the management charges are accounted for, the effective interest rate works out to be 3.75 per cent,” said Manoj Nagpal, chief executive (CEO), Outlook Asia Capital.

Individuals and corporate entities can invest a minimum of two grammes and a maximum of 500g each year. The Reserve Bank has fixed the public issue price at Rs 2,684 a gramme for the sovereign bonds, making the minimum investment amount Rs 5,368. The scheme, reportedly having garnered only a tepid response so far, is to close this Friday.

“Long-term investors, especially those invested in physical gold, will move to bond funds. Having said that, there is a place for gold ETFs and we are asking investors to continue allocating five to 10 per cent of their investment corpus in these, though the asset class is not doing well,” said Chandresh Nigam, CEO, Axis Mutual Fund.

Liquidity could, though, be a catch for bond investors. “Gold bonds cannot be bought on tap through the year but have to be invested in whenever open for subscription,” said financial planner Hemant Rustagi, who heads WiseInvest Advisors. “Also, you have to necessarily invest a lumpsum, which means timing the investment. ETFs allow you to invest regularly and average out the price through a Systematic Investment Plan.”

Nagpal says liquidity can only be gauged after the bonds are listed. “My guess is that the liquidity in these bonds will be similar or better than gold ETFs, since the trading will be done in a single product. Unlike ETFs, where the trading is done in a dozen schemes,” he said.

Notably, unlike gold ETFs, the bonds will not be backed by gold but by a sovereign guarantee. A bond will have a tenure of eight years, with an exit option on completion of five years. On maturity, these may be redeemed in cash and the principal amount (denominated in grammes of gold) redeemed at the prevailing price of the metal. This is to be linked to the previous week’s simple average of the closing price, of gold of 999-purity, published by the India Bullion and Jewellers Association.

Recently, the National Stock Exchange started a liquidity enhancement scheme for market makers to boost liquidity in ETFs listed on it.