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Money Management

How institutions caught gold fever last year

Large money managers and investors dove into gold bullion and other precious metals in a big way last year. They did so through exchange-traded funds.

ETFs that specialize in precious metals such as gold, silver and platinum netted close to $10 billion in 2016 with the bulk of the interest coming from institutions rather than small investors.

The move comes after years of outflows from the commodities sector, which was hurt by the rising U.S. dollar and the economic slowdown in China.

The golden surge helped boost total inflows into commodity funds of all types to $14.1 billion, the highest amount since 2010, when flows into commodity ETFs and mutual funds totaled $22.6 billion, according to data from Morningstar Inc.

The money that didn't go into precious metals funds last year went mainly to broad-based funds such as the $6.7 billion PIMCO Commodity Real Return Strategy. While these numbers aren't big for fixed-income or equity markets, they are substantial in the commodities field.

Although ETFs are often seen as investment vehicles for small investors, when it comes to commodities the evidence says otherwise.

For instance, the commodities fund that took in the most cash last year was State Street's SPDR Gold Shares, netting $7.2 billion in the 12-month period. Approximately 85% of the fund is owned by institutions with the largest holder being BlackRock (BLK) Fund Advisors. What's more, BlackRock alone added close to 4.7 million shares (worth approximately $500 million) in the three months ending September 2016, according to data from Morningstar. In the three months ending December 2016, the same institution dumped 2.9 million shares worth more than $300 million.

The iShares Gold Trust ETF has a similar pattern with 88% institutional holdings, the biggest of which is Windhaven Investment Management. The iShares Silver Trust ETF is 96% owned by institutions. However, many top institutional holders cater heavily to individual clients. For instance, Morgan Stanley (MS) is the third largest holder of the iShares Silver Trust, and Merrill Lynch is the fourth largest, according to Morningstar. Both have a heavy presence in the wealth management business.

Why commodity ETFs?

“Years ago access to the commodity markets was pretty clubby — you really needed to be involved in commodities in some way either by hedging or making markets,” said Jack Ablin, chief investment officer at BMO Private Bank in Chicago, which oversees $68 billion in assets for individuals and families. “Nowadays even armchair portfolio managers can get in.”

About 10 to 12 years ago BMO Private Bank made a decision to allow a strategic allocation to natural resources by using ETFs. The ETFs allowed that investment alternative without the need to establish futures trading agreements for each client, Mr. Ablin said. Every futures contract needs cash or credit for margin deposits. Sometimes margin deposits need to be topped up. Plus, futures contracts periodically expire and then need to be rolled forward to later dates in order to keep the position alive. Contrast that with ETFs, where the plan managers take care of all the hassle.

Mr. Ablin said the benefit of adding commodities allowed a heavier allocation to stocks for the same level of risk because of the diversification effect.

It's not just exposure to commodity futures that is easier. Owning physical commodities is also simpler. For instance, the SPDR Gold Shares, which owns bars of solid bullion, removed a lot of administrative burden for investors.

“I think the primary reason for the flows into the Gold Shares is ease and simplicity,” said Michael Cuggino, president and portfolio manager of the Permanent Portfolio Family of Funds, San Francisco, which has $3 billion in assets under management. “Institutional investors have the heft to buy physical commodities at reasonable prices, but there are costs such as insurance, storage and transport that are a nuisance.”

To put the hassle in perspective, prior to the creation of the SPDR Gold Shares, investors wanting to buy or sell gold bars would have a laundry list of administrative tasks to deal with. Gold bars need to be held in secure vaults and audited frequently, with special attention paid to the serial numbers on the bars. Any change in bullion holdings might have involved the transportation and the logistics of moving the bar from a possibly inconvenient location. Just because you purchased a 400-ounce bar — the standard size — from a New York bank, doesn't mean the bar is necessarily in New York. It could just as easily be in Toronto or London or Hong Kong. That's not something anyone needs to worry about with ETFs, which trade like stocks: the records are electronic.

In short, when an ETF is liquid enough, it's just simpler to buy it than to bother with purchasing and storing physical commodities or dealing with futures. That's a stark change from the past couple of decades.

Constable is a writer who specializes in economics and markets.