50% Equity + 50% Gold: How does this portfolio perform?

My mother, like many housewives, invests exclusively in gold. No bank FDs. No mutual funds. Nothing. Just gold.

Why?

Gold is easy to buy and sell. It is easy to store. It is easy to hide from husbands. Lack of comfort with any other asset. Huge conviction (that gold price goes up). Super discipline (due to the conviction and since there is no other option).

While I don’t meddle in my parents’ finances, given how gold prices have performed over the past decade, her portfolio (only gold) would have given the best fund managers and advisors a run for their money. She certainly would have beaten my portfolio.

Recently, an investor asked me, “Why do you not ask investors to put more money in gold? Why only 5-10%?”

His rationale: Gold has done well in the past 10-12 years. It is a good inflation hedge. Usually does well at times when equities are not doing well. Hence, a good diversifier.

I must concede I did not have a very cogent answer, except for the rote wisdom.

I thought of digging deeper and look at the performance over the last 12-14 years and see how well gold has really performed. While I may not still have answers to his questions after the analysis, I would at least have a firm idea about how much value gold has added in the past decade.

Would mixing gold and equity in the portfolio have added value? Higher risk or Lower Returns or both or neither?

Let’s find out.

Equity and Gold Portfolios for comparison

I consider 3 portfolios for comparison.

1. Portfolio 1: 100% Nifty 50 TRI
2. Portfolio 2: 100% Nippon India ETF Gold BeES. This is a gold
3. Portfolio 3: Combination Portfolio (50% Nippon India Gold ETF + 50% Nippon India Nifty ETF): The portfolio is rebalanced to 50:50 allocation between Nifty ETF and Gold ETF on April 1 every year. Annual portfolio rebalancing each year on April 1.

I consider data from March 16, 2007 until November 30, 2020. That’s when the gold ETF was launched.

Assumptions in the analysis

1. For this exercise, I have assumed that you buy and sell ETFs (both gold and Nifty ETFs) at day-end NAV. In real life, you must buy and sell ETFs in the secondary market. During the trading hours, the price of the underlying constituents of the ETFs and therefore the real-time NAV of the ETF will keep fluctuating. Moreover, there can be a difference between the trading price and the NAV of ETFs for various reasons.
2. Regular rebalancing in the Combination portfolio (Nifty 50 ETF and Gold ETF) will entail transaction costs and capital gains taxes. Have not considered the impact of transaction costs and capital gains taxes in this exercise. This results in an upward bias in the performance of the combination portfolio.
3. In the combination portfolio, I have considered Nifty 50 ETF. Thus, the data (NAV) considered is after management expenses and tracking error. For the Pure equity portfolio (100% Nifty 50), I have considered Nifty 50 TRI.

The Performance Comparison: Equity + Gold

I consider the performance since March 16, 2007.

The mixed portfolio (50% equity + 50% gold) has done better than both 100% gold and 100% equity portfolios.

Over this period (March 16, 2007 to November 20, 2020), Rs 100 in Nifty 50 TRI grows to Rs 423. CAGR of 11.1% p.a.

Nippon India Gold ETF: Rs 452. CAGR of 11.65% p.a.

Mixed portfolio (50% Equity + 50% Gold): Rs 521. CAGR of 12.8% p.a.

This portfolio has reaped the full benefit of portfolio rebalancing. There is a rebalancing bonus. The portfolio returns are greater than the returns of the either of the underlying assets (Nifty 50 and Gold ETF).

Notice the growth trajectory too. The growth line of the mixed portfolio is much smoother, indicating lower volatility than either 100% equity or 100% gold portfolios.

Better returns at lower volatility. What else do you want?

Given the combination portfolio is constructed, it has never been the best or the worst year portfolio in any of the 14 years.

100% equity was the best in 7 years. 100% gold portfolio was the winner in the other 7 years.

Then, how did the mixed portfolio come out the best over these 14 years?

Well, it was never the worst portfolio either.

Hence, it won by losing less.

2008: Nifty lost 51.7%. The mixed portfolio lost only 20.3%. How? Gold ETF returned 25.59%.

2011: Nifty lost 23.6%. The mixed portfolio made 2.74%. How? Gold ETF returned 30.38% in the same year.

2013: Gold lost 14.08%. The mixed portfolio lost only 3%. How? Nifty returned 8% in the year.

During the COVID-19 related market meltdown in March 2020, Nifty TRI lost 22.5% in the month of March. The mixed portfolio lost only 8.5%. How? Gold ETF gained 3.5% in the month.

That’s what happens when you mixed two assets with low or negative correlations.

What about rolling returns?

Again, good performance by the combination portfolio (50% equity + 50% gold). While it is never the best performer, it is never the worst performer either. Just look at the consistency. No negative 3-year or 5-year returns.

Both 100% equity and 100% gold portfolio had negative 3-year or 5-year returns at some point or the other.

What about Volatility and Drawdowns?

Given what have seen above, you can expect the mixed portfolio (50% equity + 50% gold) to be a big winner here.

And it is.

The portfolio has had lower drawdowns (losses).

And it has been much less volatile too.

The Caveats and Point to Note

1. This is merely a snapshot in time. The past performance may not repeat.
2. While the performance of the combination portfolio has been impressive, this data is only for 13 years. I could have dug out gold price history and used those prices instead of gold ETF. I was too lazy.
3. Gold has performed very well over the last 13-14 years. In fact, 100% gold portfolio (gold ETF) has beaten Nifty 50 TRI during the period. There is a rebalancing bonus also because both the assets have provided a similar level of returns in the period.
4. I have not considered transaction and taxation costs. Including such costs will bring down the performance of the combination portfolio. Having mentioned that, if you are in accumulation phase, rather than buying and selling (gold or equity), you can simply adjust your incremental investments in a manner that you move towards the target allocation. You will save on both transaction costs and tax costs.
5. I have considered 50:50 allocation. Why not 60:40 or 40:60? Fair question but 50:50 looks like a fine compromise. You can test for your preferred allocation. I can share the end value (as on November 30, 2020) of Rs 100 invested on March 16, 2007 in these portfolios.
6. 60% Nifty + 40% Gold = Rs 514.1 (CAGR of 12.68% p.a.)
7. 40% Nifty + 60% Gold = Rs 521.5 (CAGR of 12.8% p.a.)
8. 90% Nifty + 10% Gold = Rs 446 (CAGR of 11.5% p.a.)
9. This is back-tested data. It is easy to look back and apply strategies in hindsight. In this case, I have constructed the mixed portfolio using 2 ETFs. During this phase, there have been periods when gold has not done well over a long period. For instance, gold struggled between 2013 and 2018. How many of us would have had the patience of continue sending money to gold despite its struggle? Nifty 50 would have gone through similar phases. However, unlike equity funds, there are not many champions of gold who will keep comforting you and keep pumping hope.
10. Moreover, while we look at the portfolio performance, many of us look at the performance of individual assets too. It is difficult to send money to assets that are not doing well. As I mentioned earlier, in this case (for the period considered), everything has turned out well. It may not have. Hence, you must have conviction and the discipline to execute such a strategy.
11. Note I have considered Nifty 50 for equity portfolio. However, we are also fascinated with the best performing funds. In a bad year for gold, Nifty may give 10%. XYZ Emerging Bluechip returns 20%. The opportunity cost got a lot bigger. Need heavy conviction and discipline.
12. Gold ETF is not the only way to invest in gold. You can consider physical gold, gold mutual funds and Sovereign gold bonds.

What should you do?

I usually advise my investors to hold about 5-10% of their long-term portfolios in gold. Looking at this analysis, it would have been better if I had asked them to invest more in gold.

However, this is a snapshot in time. In my opinion, gold is a speculative asset. Hence, I am not comfortable routing a major chunk of my portfolio towards gold (my opinion might change in the future).

I do not know much about commodity pricing. However, easier liquidity conditions since the financial crisis in 2008 might have helped gold price. Rupee also depreciated too during this period. Nonetheless, gold has added to portfolio diversification and we already know that it is a good hedge against inflation.

Additionally, when I speak about 5-10% allocation to gold, that is for the entire portfolio. Based on your life stage (and risk appetite), there can be, say, 40-45% debt and about 45-50% in equity. Within equity, there will be a good allocation to international equities too. And we have seen earlier that adding international equity can add value. With that info, 5-10% gold may not look too bad.

How much do you prefer to invest in gold?

Data Source

NiftyIndices

ValueResearchOnline