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Sovereign gold bonds versus gold ETFs

Sovereign gold bonds offer several advantages over ETFs in the form of interest payments, favourable tax treatment and lower expenses

Sovereign gold bonds versus gold ETFs

With a fresh tranche of sovereign gold bonds on sale, it's a good time to review how these instruments stack up against the earlier favourite, gold exchange traded funds or ETFs. Just based on returns and taxation, the bonds seem better.

Sovereign gold bonds (SGBs) are issued by the Government of India. The issue price for the fourth tranche of Sovereign Gold Bond Scheme, opening on July 18 and closing on July 22, has been fixed at ₹3,119 per gram. One can buy a minimum of 1 gram and a maximum of 500 grams. In comparison, gold ETFs are sold based on net asset value (NAV) through the exchanges. These NAVs currently start below ₹500 (per unit). Both SGBs and Gold ETFs, which help you to hold gold in paper form have big advantages over physical gold. They don't have purity issues, they don't force you to shell out hefty locker rents and they offer liquidity at prevailing gold prices without ad hoc deductions for wastage or losses.

Advantage SGB
But having said this, how do SGBs compare to ETFs? One area where the SGBs score over gold ETFs is the sovereign guarantee. The government guarantee, a good marketing ploy, is applicable both on the redemption amount and on the interest. Gold ETFs are offered by private sector AMCs and do not have that kind of advantage. But do note that the sovereign guarantee here does not shield investors' capital from volatile gold prices. Both the value of your SGB and the value of your ETF swing up and down with market prices of gold during your holding period.

Secondly, SGBs pay you an assured interest over and above the price returns on gold. Gold ETFs do not give you that comfort and rely only on price returns. Gold bonds offer 2.75% per annum (paid half-yearly) on the initial investment. Thus, investors earn returns linked to the gold price (just like in gold ETFs) plus a fixed annual interest income. The tenure of gold bonds is 8 years but exit options are available in the 5th, 6th and 7 year.

SGBs are cheaper to own than gold ETFs too. This is because gold ETFs charge management charges of up to 1% of their net assets every year. But gold bonds do not have any such recurring charges.

Tax sops for gold bonds
Thirdly, there is a tax advantage on SGBs too. Budget 2016-17 has exempted the redemption of these bonds by individuals on maturity from capital gains tax. No TDS is applicable on the interest earned from those bonds.

Gold ETFs, on the other hand, are treated as non-equity investments. Therefore, short-term capital gains on units held for less than 36 months are added to investor's income and taxed as per the applicable slab rate. Long term capital gains on units held for more than 36 months are taxed at a rate of 20% after providing for indexation benefits on costs. Gold bonds get indexation benefit if they are transferred before maturity.

Given that SGBs score over ETFs on these three counts, will the gold ETF assets in the MF industry see a shift to these bonds? Chirag Mehta, senior fund manager - alternative investments, Quantum AMC, says: "That kind of shift is not happening right now. Gold bonds are a new product and investors are still learning about them. An issue about gold bonds is that they are not on-tap. Investors have to wait for the government to sell a new tranche. You cannot go and buy them whenever you want. Also, some investors prefer to buy smaller denominations than a gram which can be done via gold ETFs, but not gold bonds."

Gold bonds and gold ETFs are listed on exchanges, which means you could exit them in the secondary market if you require the money before maturity. The redemption will be done at the prevailing price at the market. "However, gold ETFs have better liquidity (than SGBs). They register far higher volumes than gold bonds at present," says Anil Rego, Founder and CEO of financial consulting firm Right Horizons. The liquidity issue is a major one. The exchange bid-ask spread for SGBs, a relatively new instrument with a short trading history, is pretty high compared to gold ETFs.

Gold ETF performance
If you are betting on SGBs or gold ETFs for price appreciation though, you are likely to get similar results. While gold ETFs have sparkled recently, their long term performance has been unimpressive. Their 5-year returns are in 6.3-6.5% p.a. range as on June 30.

"Investors should choose based on their liquidity requirements. If liquidity isn't important and investors can hold to maturity, gold bonds are superior. If investors feel they may need liquidity, ETFs are superior," said Rajiv Shastri, CEO, Peerless MF.