Understanding risks, rewards of sovereign gold bonds

The first tranche of SGBs, launched in 2015, has delivered impressive returns, outperforming both the broader equity market and gold ETFs. Investors who held the bonds until maturity enjoyed cumulative returns of 12.9% per annum, highlighting the potential of SGBs as a long-term investment tool

Just last week, the Sovereign Gold Bonds (SGB) tranche has come up for maturity. The first and initial SGB offering was issued to public in November 2015 with a maturity of eight years. The returns on this fund are a combination of interest earned and the change in the gold price. India has continued as one of the highest, if not the highest consumer of gold over the years. Most of the gold is imported and is a cause of concern for the foreign exchange. In fact, the import bill has hurt the Indian rupee over the years and to counter this, the government in 2015 came with an alternative to address this insatiable demand.

These bonds are being issued by the Reserve Bank of India (RBI) to wean away the interest of the consumers towards physical gold thus reducing the import bill for the government. The tenor or tenure of these bonds is for a period of eight years with an exit option from fifth year onwards, the call (exit) option should be exercised on the interest payment dates only. These bonds could be invested by individuals, HUFs (Hindu Undivided Family), Trusts, Universities and other charitable institutions. These bonds are denominated in units of one gram of gold and multiples thereof with a minimum permissible investment of 1gm of gold. The maximum limit for subscription is 4 kg for individuals and HUFs while it is 20 kg for trusts and other institutions. These bonds come with an interest of 2.5 per cent payable semi-annually.

The interest rate initially was at 2.75 per cent (for the first tranche of the SGBs). The nominal value of the bond based on the simple average closing price (published by the India Bullion and Jewellers Association Ltd) for Gold of 999 purity of the last three business days of the week preceding the subscription period. RBI in its release further said that govt has decided to offer a discount of Rs 50 per gram to those investors applying online and where the payment against the application is made through digital mode.

The SGB-I was launched in 2015 were allotted units at Rs 2684 per gm have encashed the units at Rs 6132 per gm, while enjoying the guaranteed return of 2.75 per cent. For those who have continued to stay invested till the maturity, the returns (price change and interest) cumulated to 12.9 per cent per annum. For comparison, the broader equity benchmark, NIFTY50 index returned about 12 per cent and the gilts (govt. securities) 7 per cent for the same period. This has also outperformed the gold ETFs (Exchange Traded Funds) for the same period due to the additional guaranteed interest earned over the bonds during this period. The tax treatment of the interest earned on these bonds is considered as per the capital gains. There is no capital gains tax upon redemption, but an indexation benefit is provided for investors trading these bonds i.e., upon the interest earned.

Though, India is currently at a better situation, the global macros i.e., public debt, government deficit, fiat currency continuity and geo-political conflicts have gone up in the recent past, across the world, gold seems to be a perfect hedge. The increasing allocation of central banks in recent quarters towards gold also bolsters the case for gold. But, one should understand the rationale and purpose of SGB while making any allocations in their portfolio.

These bonds are sovereign guaranteed but aren’t issued against any real gold (deposits). So, the biggest and possibly the only risk is the sovereign default (which is an extreme but that’s reality). So, these bonds unlike the gold ETF is not backed by physical gold. Those who wanted a diversification or not willing to expose/invest in gold directly could take advantage of the guaranteed interest and tax benefits while holding till maturity. Of course, reinvestment risk is prevalent and one may not get an opportunist time to reinvest, though they’re traded in the secondary market.

These bonds, however, could be used as collateral for loans. The other important feature of these bonds is the transferability which are treated at par with that of provisions of the Government Securities Act. These bonds are tradable on the stock exchanges within the fortnight of the issuance date. Like any other investment avenues, the disclaimer of ‘past returns don’t guarantee the future returns’, apply here. So, please keep your expectation based on the investment rationale (why these bonds are issued at the first place).

(The author is a co-founder of “Wealocity”, a wealth management firm and could be reached at [email protected])