Alternative Investment 

How can gold fit into a portfolio?

This article is part of
Guide to investing in alternatives

How can gold fit into a portfolio?

Gold, which holds a certain appeal for investors, can be categorised as an alternative investment.

Advisers and investment managers are often divided over whether an investor needs an allocation to gold in a portfolio at all, and if they do, how much it should account for.

Gold is probably best known as being a defensive asset. Over the years it has earned the name ‘safe haven asset’ because it is uncorrelated to bonds and equities.

For this reason, it can be a useful diversifier in a portfolio but like many alternative assets, it is not always clear how best to get exposure.

Alex Scott, deputy chief investment officer at Seven Investment Management, believes there is a decent case for holding gold.

“We think well diversified portfolios can justify having some exposure to gold at present,” he says. “Low real yields are quite a helpful backdrop for gold as they reduce the ‘opportunity cost’ of holding gold, which of course produces no income, versus having cash on deposit instead.

“Gold has shown low correlation to both equities and bonds over time, and has potential as a hedge both against known risks – inflation, political/financial instability, US dollar weakness – and unknown or undefined risks.”

Going for gold

But Nick Hammond, executive director at Baird & Co believes gold is and always has been difficult to place in investment strategies. 

He explains: “On the one hand it is viewed as a safe haven providing insurance against tail risk events, as it did during the 2008 financial crisis.

"On the other hand it can sometimes behave more like a ‘risk on’ asset. For instance, the gold price has dipped along with equities these last few weeks.

“It comes down to the fact that assets display different correlation characteristics over different timescales. If you look at gold versus benchmark bond and equity ETFs over a 10-year period, you will see clearly that gold is relatively uncorrelated to these asset classes. In times of market and geopolitical stress, it is a fantastic ‘insurance policy’.”

BullionVault has an interactive tool on its website which shows investors the impact of adding gold to a 60:40 equity:bond portfolio.

According to BullionVault in a portfolio of UK investment assets, the value of gold as investment insurance has been great for hedging UK assets over the last 40 and 20 years.

Figure 1: Diversifying a simple UK portfolio with gold, 1977-2016

RiskNo gold    5% gold   10% gold   25% gold
Worst 1-year loss in per cent (2008)-13.1-10.4-7.6-9.2*
Worst 5 years (2000-04, annualised return)11.21.42.1
     
Total returns (no costs or tax)No gold5% gold10% gold25% gold
1077-2016 compound annual growth12.412.312.111.4
Last 20 years compound growth rate7.87.988.2
Average 5 years (middle of range, annual)12.912.511.710.8

*1990 figure; 2008 +0.8%

Source: BullionVault

It reveals having 10 per cent in gold almost halved the losses of 2008 on a simple 60:40 portfolio of UK equities and government bonds, while going 25 per cent gold reduced that risk still further.

However, over a longer period buying gold has made UK portfolios a little more volatile, cutting the overall annualised rate of return since 1977, according to BullionVault’s calculations.