Should you replace your gold ETFs with EGRs?

In early May, the National Stock Exchange of India (NSE) announced the launch of its Electronic Gold Receipts (EGRs). And earlier this week, NSE commenced trading of EGRs. In this article, we analyse how they compare with other gold investment options and whether they deserve a place in your portfolio. Let’s dive in.

What is an EGR?

Let’s first explain the basics of Electronic Gold Receipts (EGR), and then move on to the pros and cons between these and other modes of gold investment currently available.

EGR basics: EGRs are exchange-traded securities linked to standardized physical gold of specific purity and mass. They are available in two purity levels: 999 and 995. Here, 999 implies 99.9% purity and 995 implies 99.5%.

Note that 999 and 995 purity do not directly correspond to the more familiar 24 karat and 22 karat gold. While 24 karat gold has about 99.9% purity, 22 karat gold has a much lower purity of 91.67%. This lower-purity gold is typically used in jewellery, where it is reinforced with other metals to improve strength. In contrast, 24 karat gold is softer and is mostly used for investment purposes.

Within each purity level, five different denominations are available under the EGR structure: 100 mg, 1 g, 10 g, 100 g, and 1 kg. At an assumed gold price of Rs. 15,000 per gram, the smallest unit (100 mg) would cost Rs. 1,500, while the largest unit (1 kg) would cost Rs. 1.5 crore.

Gold backing: Each EGR is backed by physical gold. Under the EGR structure, a Vault Manager (VM) provides storage facilities where physical gold is held, and EGRs are issued against this gold. Depositors can deposit gold with VMs after it undergoes a purity test. Currently, vault and collection centres are set up in Ahmedabad and Mumbai, and 4 more centres in other cities will come up soon. NSE’s eventual plan is to have a network of about 120 centres.

The Securities and Exchange Board of India (SEBI) has issued detailed guidelines to ensure the safety of the underlying gold. These include mandatory insurance for the full value of the gold stored, daily reconciliation between outstanding EGRs and physical gold, and the option for EGR holders to request assaying of the gold at any time.

Investing in EGRs: EGRs will be listed on stock exchanges. To invest, you need a trading and demat account, and your broker should enable the EGR facility. The experience should be similar to trading stocks or ETFs.

Going by SEBI’s guidelines, price bands are placed on orders in the EGR segment – the initial price band will be 10%+/- from the previous close and your orders need to be within this. During significant market movements, the exchange can change this band in 5% increments. 

Conversion to physical gold: This is where an EGR is very different from gold ETFs or mutual funds. An EGR can be withdrawn in physical gold – i.e., while you buy the EGR on the exchange, you can choose to sell on the exchange or convert it into physical gold. The withdrawal unit will be the same as what the EGR represents.

Such a request goes through your depository, who in turn sends it to the vault manager for processing. The EGR representing this withdrawn physical gold withdrawal will be cancelled. As we understand currently, collection of such physical gold needs to be done by you from the vault manager. You can choose the vault manager at the time of placing the withdrawal request. 

Costs: There are costs associated with storing physical gold under the EGR structure. These are charged to the EGR holder. This will be in addition to other charges such as brokerage and demat charges.

Taxation: The taxation of EGRs is similar to that of Gold ETFs. If sold within 12 months, the gains are treated as short-term capital gains and taxed at the investor’s slab rate. If sold after 12 months, the gains are taxed at 12.5% without indexation.

Comparing EGRs and Gold ETFs/ Mutual Funds

With the basics covered, let’s look at how this product compares with alternative options from the perspective of different investors.

#1 Gold ETF buyer

EGRs, in their proposed form, are most comparable to Gold ETFs. Let’s look at key aspects to evaluate EGRs against Gold ETFs.

Assets: Both Gold ETFs and EGRs hold physical gold. However, EGRs represent 100% physical gold of specified purity, whereas Gold ETFs typically hold about 98%–99% in physical gold, with the balance in cash or equivalents.

The 999 purity in EGRs may be higher than the purity of gold held by some ETFs; however, this alone does not result in higher returns. For example, if 999 gold is priced at Rs. 15,000 per gram and 995 gold at Rs. 14,940, and both rise to Rs. 15,350 and Rs. 15,290 respectively, the return for both investors would be the same at 2.34%.

What can make a difference is the cash component. If gold rallies sharply; for instance, by 10% in a month; EGRs could reflect the full 10% gain, whereas an ETF holding 2% cash may deliver slightly lower returns, say around 9.8% (excluding costs).

Costs: Gold ETFs charge an expense ratio for management. As per the latest disclosures, expense ratios for India’s largest Gold ETFs range from 0.5% to 0.8%.

In contrast, EGR costs are levied separately. The Vault Manager determines these charges, which are collected via depositories. While this suggests a fixed periodic fee (unlike the percentage-based expense ratio of ETFs), Vault Managers can revise fees with 15 days’ notice.

Since Vault Managers must insure the full value of gold and insurance costs typically rise with gold prices; it is likely that storage charges may increase when gold prices rise. A meaningful comparison with ETFs will be possible only after these charges are known. 

To put it in perspective, at an assumed gold price of Rs. 15,000 per gram, the monthly storage cost per gram must be below Rs. 6.25 for EGRs to be cheaper than ETFs.

Convenience: Monthly storage fees may be inconvenient, as investors need to maintain sufficient balance in their ledger accounts to avoid penalties. If an investor sells EGRs mid-month, depositories will collect fees at the time of sale. In comparison, Gold ETFs deduct expenses daily from the fund’s assets, making them more seamless from an investor’s perspective.

Liquidity:
Gold ETFs are well established in India, with several ETFs recording daily trading volumes exceeding Rs. 100 crore. It remains to be seen how liquidity in EGRs develops over time.

To sum up:
EGRs do pose a potential challenge to Gold ETFs. However, investors may be better off taking a wait-and-watch approach, as with most new investment options. Key factors to track include liquidity, costs, and how EGRs performance post costs compare with established Gold ETFs over time.

The table below summarizes the differences above:

#2 Gold mutual fund buyer

If you invest in gold through mutual funds despite having access to lower-cost ETFs; you likely prefer the convenience they offer. This includes those without demat/trading accounts, transacting outside exchanges, avoiding bid-ask spreads and liquidity concerns, and investing through SIPs or in flexible amounts rather than fixed unit sizes.

In such cases, EGRs are unlikely to be appealing to you, as they share characteristics with gold ETFs, including exchange-based trading and unit-based transactions.

#3 Physical gold buyer 

If you invest in physical gold bars, coins, or jewellery, you likely value having direct access to your gold. In that case, EGRs may not be very appealing. 

However, if your preference for physical gold comes from wanting your gold allocation to be fully invested (as opposed to Gold ETFs or mutual funds, which may hold 1%–2% in cash for liquidity purpose), EGRs are worth considering. They offer complete exposure to gold at your preferred purity of 99.5% or 99.9%.

Do note that if you plan to take physical delivery, a 3% GST will apply on the delivery value. This is the same GST applicable to gold bars and coins. In addition, a withdrawal charge will apply, which will be specified by the Vault Manager.

All this said, there are several investors who still prefer physical gold. Even for them, EGRs would be a good option given their fungibility into physical gold. Storage risks and quality control are also undertaken by the vault manager.

#4 Digital gold buyer

In recent years, several private players have offered digital gold investment options. If you currently invest through such platforms for whatever reason, shifting to EGRs will be the better option.

EGRs come with stronger regulatory safeguards, as they fall under the oversight of the SEBI, with clear rules for investor protection. Digital gold is not recognized by SEBI and poses significant risks in the absence of any regulations (SEBI, in fact, even cautioned investors against e-gold a while ago). EGRs also offer greater transparency compared to many private digital gold platforms.

While private digital gold platforms typically allow investors to transact without a demat account, EGRs require a trading and demat account. This is a reasonable trade-off for the safety and regulatory oversight.

Conclusion

Electronic Gold Receipts are a promising addition for those who want a product that closely tracks gold prices, can be converted into physical gold, and is backed by a clear regulatory structure. That said, the practical appeal of EGRs will depend on costs, liquidity, and ease of use. For now, those already using gold ETFs or funds have no reason to make a switch into EGRs. For those with a love for physical gold, EGRs do present a better option.