Should you opt for the Gold Bonds redemption window?

Under the terms of the Sovereign Gold Bonds, the RBI will provide liquidity on gold bonds after completion of 5 years, although the bond redemption will only happen after 8 years.

May 31, 2021 11:05 IST India Infoline News Service

In the last few days, there have been a lot of reports about the redemption of gold bonds First Tranche of November 2015, which came due for second redemption on 29 May. Under the terms of the Sovereign Gold Bonds, the RBI will provide liquidity on gold bonds after completion of 5 years, although the bond redemption will only happen after 8 years.

This early redemption facility will be offered by the RBI on every tranche of gold bonds after the fifth year completion at 6-month intervals. The November 2015 issue had its first redemption window in November 2020 and this is the second redemption window. Just like the first tranche, you will now have a series of such early redemptions from the RBI window on a regular basis. The question is how to take a decision whether to opt for early redemption or not.

An amazing 80% capital gains on Tranche-1 SGB; oh really?

Numbers can be misleading and smart numbers can be smartly misleading. If you got carried away by reports that the SGB is being redeemed by the RBI at 80% higher price, just think again. Does that really amount to substantial gains and is an early redemption decision justified? Let us focus on the absolute returns for now.

Tranche Buy Price Redeem Price Interest Paid XIRR (%) Yield
Nov-2015 Rs2,684 Rs4,837 Rs406 12.92%

The interest on the first tranche was paid at 2.75% and if you add that your annualized yield comes to around 12.92%, when you consider the internal rate of return over 5 years and 6 months. Now that is putting things in perspective. How does this look when compared with the Nifty index returns. During this same 5.5 years, if you consider the Nifty CAGR returns, it has given an IRR of 13.50% absolute. If you add the approximate dividend yield of 1.45%, you are looking at CAGR returns of closer to 15% on the Nifty in total return terms. That assumption is not entirely off the mark because if you consider the Nippon Nifty BEES, it has generated CAGR returns of 14.85% in this period. But, these are pre-tax returns, so let us also look at post-tax returns.

Would early redemption be subject to capital gains tax?

The terms of the SGB issue based on the subsequent notification issued only makes redemption of sovereign gold bonds at the end of 8 years free of capital gains tax. The fifth and sixth year windows are just meant to provide liquidity to those who need the liquidity. As we have seen, the secondary market liquidity of SGBs is very thin even though they are listed on the stock exchanges. Early redemption at the end of 5.5 years would be treated as long-term capital gains, since the holding period in this case is more than 36 months.

The issue period of the bond is FY16 so the applicable index as per the Income Tax Act will be 254. The index number for FY22 is not yet announced so we will extrapolate it based on last five years data at 310. Here is how the post-tax returns on the early redemption will look like in this case.

Particulars Amount
Issue price of SGB Tranche 1 2015-16 Rs2,684
Indexed cost of acquisition (factor 310/254) Rs.3,276
Redemption price Rs.4,837
Indexed Capital gains on early SGB redemption Rs.1,561
Tax at 20% on indexed Gains Rs.312
Effective redemption price (4,837 – 312) Rs.4,525
Interest receipt of Rs406, net of 30% tax Rs.285
Total Post Tax annualized yield (XIRR) 11.20%

Frankly speaking, the post-tax yield that you would get on early redemption is 11.2%, which is a reasonably good return in post-tax terms. Hence, if you require liquidity and don’t want to wait till 8 years, you can opt for early redemption, as the tax impact on yields is not too much. Of course, for each tranche redemption window, the yields would change depending on the issue price and the redemption price, but this is how to view it. The real issue is that you must be driven by asset allocation and not liquidity or returns.

Gold bond redemption should be an asset allocation decision

To redeem or not to redeem in this early window should be ideally guided by your asset allocation. Here is what it means. Normally, your gold allocation should be in the range of 10-15% of your overall financial portfolio allocation. Now, in case your allocation in the last few years has crossed 20%, it is time to re-allocate out of gold. In that case, you can use the early redemption window of the RBI as the post-tax yields appear to be fairly attractive. Gold may still be an attractive asset class, but remember it is a hedge for your portfolio, not a return enhancer!

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