There is No Fate But What We Make: Investing in Gold asset class

Thursday, January 01, 2009

Investing in Gold asset class

A portfolio should consist of diversified and uncorrelated assets. To that end, investing in gold (and commodities in general) should be part of portfolios of 10 years or longer duration. 5% of networth can be kept in this. (Of course a portfolio depends on many factors but here we are talking about the median portfolio).

How do we invest in gold ?
Indians have a voracious appetite for gold. In fact, Indians are probably THE largest consumer of gold. So it's odd to suggest to Indians to invest in gold.

The issue is Indians buy ornamental jewelery and there's a huge cost of acquisition/ownership with ornamental jewelery -
1. Making charges
2. Wastage
3. Taxes
4. Locker charge
This is akin to entry loads and expense ratios for mutual funds. I analyzed jewelery purchase from a leading place in Bangalore and the "entry load" is nearly 40%! This pales the entry loads of even many ULIPs! There's also a risk of theft, loss and impurity with jewelery purchases.

A much better option is to invest in Gold ETFs. An AMC pools in money from retail investors and keeps gold of certified purity. The entry load is just the brokerage (typically 0.25% to 0.75%). The annual expense ratio is about 1% and it certifies purity and insulates against theft and such losses.

Someone asked me about DSP BR World Gold Fund.
DSP BR World Gold Fund is a mutual fund that invests a part of its corpus in shares of companies involved in gold business such as mining.

The returns from this and Gold ETF are correlated but not exactly the same.

If the goal is to hedge portfolio risks by keeping a part of your assets in gold, Gold ETF is what you should invest in. It tracks gold prices better and has lower expense ratio. It also avoids company specific risks. I cannot think of a single reason for opting for DSP BR World Gold Fund
over Gold ETF.

There are two Gold ETFs available in India:
Benchmark Gold ETF
UTI Gold ETF

To choose between the two, consider the following:
1. Pedigree of the AMC
2. Expense ratio (lower, the better)
3. Asset size (larger, the better as it distributes the fixed costs over a bigger pool)

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