Gold – A classic asset class

Gold has been historically considered as an important asset class mainly for three reasons:

 

• Hedge against inflation
• Adds stability to the investment portfolio
• Asset Allocation avenue

 

And as an asset class, gold over the year has shown a secular uptrend. In 1971, the price of gold was about U.S. dollar 32 an ounce and today (i.e. on February 18, 2011) it is U.S. dollar 1,383.50 an ounce –which indicates that price of gold has gone up by 42 times over the last 40 years. Even in the last 13 years (i.e. since Jan 1998) as depicted in the chart hereunder, till February 18, 2011 gold prices have appreciated by whooping 380% (on an absolute basis).

 

(Source: World Gold Council, IHB Global Insight)

 

Whenever, Governments and central banks of the world exhibit financial exuberance, thus raising chances of economic turmoil in the form of ballooning fiscal deficit, inflationary situation, slowing economic growth rate, high unemployment rate etc; smart and prudent investors prefer taking refuge under gold which makes this asset class look bold. And when all such downbeat economic data is released, if the central banks the world resort to printing more money (in order to take the economy out of the woods), it in effect puts downward pressures on the dominant currency – such as the U.S. dollar, which in turn fuels the upward movement of gold.

 

In the year gone by (in 2010) too, Euro zone - especially Greece, Ireland and Spain continued to experience burgeoning debt crisis. The U.S. economy too for the major part of the year suffered the pain of high unemployment rate, low economic growth rate and low consumer confidence; which eventually led to stimulus package being announced in the form of QEII, in an attempt to revive their (U.S.) economy. In India the political uncertainty caused due to several scams such as the 2G spectrum scam, Adarsh Housing Society Scam and the housing finance scam, also led to the precious yellow metal becoming bolder (rose by 23%). Moreover, gold merchants also maintained elevated stock levels, as physical demand also remained robust due to several auspicious muhuraths during the year.

 

Talking about the year ahead, as the U.S. economy is still paper driven (due to QEII announcement), we may witness a weakening of the U.S dollar which may keep an upward bias on the prices of gold (gold prices and the U.S dollar are inversely related to each other). Moreover, interestingly post the QEII announcement we have witnessed a sudden rally in commodities, which may also gather investor’s attention to gold. In the Euro zone too – Greece, Ireland and Spain are experiencing a “debt overhang”, which reveals that they are still not out of the woods; which may also tempt investors to continue to take refuge in this precious yellow metal thus leading to its secular uptrend kept unharmed. In fact knowing that the economic recovery is wobbly, most economies led by the U.S. and the Euro zone ones are maintaining elevated levels of gold reserves too (as revealed by the chart below), in order to hedge the risk of an economic breakdown.

 

(Source: World Gold Council, PersonalFN Research)

 

Hence taking into account the fundamentals for gold presented above, we strongly believe that gold as an asset class makes a strong case for inclusion in one’s portfolio (as it would insure / hedge your portfolio against the various risks it is exposed to).

 

But let’s assess whether investing in gold through “Kotak Gold Fund” (KGF) (a recent introduction to the product portfolio of Kotak Mahindra Mutual Fund) would be a prudent investment decision.

   

Positioning of the fund

Primarily let us apprise you that KGF, is not a gold ETF (Exchange Traded Fund) but in fact a Gold Fund of Fund (GFoF). As per its offer document, the investment objective of the fund is “to generate returns by investing in units of Kotak Gold ETF.” Hence to simply put, KGF is positioned as a “feeder fund” which invests its corpus into Kotak Gold Exchange Traded Fund (KGETF), (which in turn invests in physical gold) and its (KGF’s) performance would be closely linked to the performance of the underlying fund - KGETF.

 

Thus being passively managed, KGF enables its investors to invest in gold through a paper form, thereby providing the convenience of Systematic Investment Plan (SIP) as well as lump sum investments, but without having its investors to open a demat account to avail its benefits (which is unlike Gold ETFs). Since SIP is a special feature of KGF, it provides the convenience and advantage of rupee-cost averaging and compounding to its investors. Also since holding a demat account is not necessary, investors would not have to incur charges such as annual maintenance charge for demat account, delivery brokerage charges, transaction charges (while investing in demat mode) etc; thus making it a cost effective investment proposition.

 

Moreover liquidity too is not restrained by the fund, as investors can subscribe and redeem units on all business days directly from the AMC (while purchase and sale of gold ETFs depends upon the liquidity on the exchange).

 

Portfolio & Investment Strategy

KGF’s portfolio will predominantly constitute of investments in Kotak Gold ETFs (KGETF), but not ruling out upto 5% allocation towards debt and money market instruments.

 

Type of Instrument	% of Net Asset	Risk Profile
Units of KGETF	95 % - 100 %	Low
Reverse repo and /or CBLO and/or short-term fixed deposits and /or money market instruments and/or Schemes which invest predominantly in the money market securities or Liquid Schemes*	0 % - 20 %	Low

 

*The Fund Manager may invest in liquid schemes of Kotak Mahindra Mutual Fund. However, the Fund Manager may invest in any other scheme of a mutual fund registered with SEBI, which invest predominantly in the money market securities
(Source: Scheme Information Document)

 

KGETF too which is the underlying fund, invests in physical gold which consists of fineness (or purity) of 995 parts per 1000 (99.5%) or higher. Thus KGF being a feeder fund would be focused providing returns that closely correspond to the returns provided by KGETF.

 

Performance of the underlying fund - KGETF

So far as revealed by the chart below, KGETF – the underlying fund, (since November 13, 2007) has provided luring returns of 97.4% on an absolute basis, while 22.9% on a CAGR basis.

 

(Base: 10,000)
Note: Gold prices are of MCX gold
(Source: ACE MF, PersonalFN Research)

 

How GETFs have fared

Gold Exchange Traded Funds	Absolute		CAGR			Tracking Error	Expense Ratio (%)	% holding in Gold	% holding in Cash
1 Month	3 Months	1 Year	2 Years	3 Years
Gold BeES	5.62	1.61	22.72	14.73	17.87	0.83%	1.00	99.96	0.04
UTI Gold ETF	5.63	1.61	22.78	14.67	17.77	1.22%	1.00	111.56	-11.56
Quantum Gold ETF	5.64	1.62	21.96	14.60	17.76	0.11%	1.00	99.99	0.01
Kotak GOLD ETF	5.62	1.61	22.74	14.57	17.73	2.51%	1.00	100.00	0.00
Reliance Gold ETF	5.63	1.65	22.79	14.60	17.13	2.21%	1.00	99.45	0.55
Gold-India (Benchmark)	5.81	2.21	23.63	16.22	19.03	-	-	-	-

Performance as on February 28, 2011, Portfolio details are the latest available.
(Source: ACE MF, PersonalFN Research)

 

Even when judged in comparison to its peers, the table above reveals that KGETF has delivered competitive returns across time frames, but that has come with some variation in the tracking error when compared to its peers.

 

Taxation

On the taxation front too as per the present tax laws (Income Tax Act, 1961), investment in KGF would enable investors to avail the benefit of long-term capital gains tax, after the period of one year of its holding. However, any sale of the fund before the period of 1 year would attract short-term capital gains tax.

 

It is noteworthy that at present for investment in physical gold, the benefit of long-term capital gains tax is available only after the completion of period 3 years of the asset’s holding.

 

Fund Manager Profile

KGF will be managed by Mr. Abhishek Bisen who holds a BA Management along with an MBA in Finance. He has been associated with Kotak Mahindra Mutual Fund since October 2006. Prior to joining the mutual fund arena, Mr. Bisen was working with Securities Trading Corporation of India Ltd. where he was looking at Sales & Trading of Fixed Income Products apart from doing Portfolio Advisory. He also has two years of experience as a merchant banker.

 

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Add Comments

Comments
mirandaallgood@yahoo.com Aug 28, 2012 Certainly at IRA is the best place for because of the tax qiostuen Roth IRA is best. GLD is your best option. You might also consider CVX. It pays a dividend. My personal option is that oil might be better than . It is being consumed. Gold isn't. But I might be wrong on that point. Governments do have a habit of confiscation when it is politically expedient. Oil companies could be a target. The hard gold and hard silver out of government's site is pretty much immune from confiscation. Don't put it past them. It appears that that many have already come to that conclusion.
nicoleflourweens@yahoo.co.nz Jan 12, 2012 Gold Exchange traded fund is directly tied to the gold price. When you invest in this Exchange traded fund, the manager uses those funds to buy gold bullions. These types of bullions are then stored in a vault.

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