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Simon Midgen, index strategist at LGIM

Precious metal ETPs dominate net inflows in Europe

By James Williams – Last year net new assets into commodity ETPs were USD23.1billion, up from USD15.1billion the year before according to the London-based exchange traded funds consulting firm ETFGI.

The vast majority of those inflows went into precious metals, taking in a whopping USD20.3billion, with broad-based commodities taking in USD2.8billion and energy around USD1.1billion.

Within Europe, the story was much the same. “Of the USD8.9billion in net new inflows into commodity ETPs (up from USD6.4billion in 2011), USD7.8billion went into precious metals. The top five commodity products in Europe in terms of net inflows were all gold ETPs,” confirms Deborah Fuhr, co-founder of ETFGI. One of those was the Source Physical Gold P-ETC (SGLD).

Last year, total turnover of USD7.5billion made it the second most traded ETP on the London Stock Exchange. With over USD4billion in total assets it is now among the largest physical gold ETPs in the world, along with ETF Securities Physical Gold ETC (PHAU) and iShares Physical Gold ETC (SGLN). It is also one of the most cost-efficient products with a 0.29 per cent annual fee.

“In general, ETF providers are becoming more competitive on annual fees, trading liquidity etc. The array of physical gold ETPs has expanded rapidly over the past few years,” notes Stefan Garcia, Managing Director at Source.

Although last January saw net outflows of USD75-100million as investors rotated into equities, sentiment soon changed as the European debt crisis prompted investors to pile back into the safe haven asset. “By the end of the year net inflows had reached USD1.6billion,” confirms Garcia.

Quite how 2013 will play out is too early to call. Emerging market central banks are continuing to diversify away from US dollars into gold bullion. This could support some further upward price momentum, even with expected US economic growth. Another interesting dynamic that could support further growth in physical gold ETPs is that asset managers are incorporating them into their portfolios to hedge against negative movements in the equity markets.

Adds Garcia: “Some fund managers in large natural resources funds have been using physically-backed ETPs in their holdings for some time. As an active manager they realise they still need to visit mining companies but there’s a benefit to holding the actual commodity itself.”

Other precious metal ETPs that are locking in strong performance include SPGS Platinum ETN EUR, which has returned 11.31 per cent over a 1-year period, while ETF Securities’ Physical Platinum ETC is up 14.34 per cent YTD. “We are starting to see some interest from our larger investors in platinum and palladium. If China picks up it’ll have the world’s largest auto market in the next few years and while we haven’t seen massive inflows yet, investors understand that strategically it makes sense to diversify into these metals,” says Garcia.

What makes platinum and palladium interesting is that both have tight supply constraints and are forecast to go into deficit this year. Nicholas Brooks, head of research and investment strategy, ETF Securities, believes that platinum and palladium could represent “some of the most interesting commodities in 2013”.

“Around 80 per cent of platinum is produced in South Africa which is having severe labour and power problems at the mines; given that the markets are so tight any indication that there might be further problems on the supply side would support higher prices. Palladium is less concentrated from a supply perspective, around 40% comes out of South Africa, but it is primarily used for automobile catalysts which is basically a great way to play the China, US and India growth story,” says Brooks.

He adds that while interest has undoubtedly picked up in these single commodity ETCs, investors are also increasingly starting to favour the ETFS Physical Precious Metals basket (PHPM), which holds gold, silver, platinum and palladium physically backed by bullion.

“Retail investors in particular, who didn’t want to take a single view, like more of a diversified approach. If you get your call right on palladium, for example, by investing solely in ETFS Physical Palladium (PHPD) you could shoot out the lights performance-wise, whereas by diversifying you reduce the volatility and the potential returns as well.”

This broad-based basket has attracted USD5.9million through January 2013; total assets are USD678million.

One firm that has responded to investor concerns over the complexities of investing in commodities is Legal & General Investment Management, who in January 2012 introduced the LGIM® Commodity Composite IndexTM. The firm used a sophisticated quantitative and qualitative process to optimize exposure to a selection of best of breed commodity indices by evaluating more than 350 indices from 17 different providers to build an index capable of giving investors simple access to broad-based commodities.

Currently, the index is comprised of four individual indices: Barclays Capital Commodity Index Pure Beta TR; Citi CUBES Index TR; JPMCCI Ex-Front Month Energy Light Index TR, and UBS Bloomberg Constant Maturity Commodity Index.

“These indices are second generation indices that aim to optimise the roll yield and reflect the performance of the underlying commodity assets as best they can,” explains Simon Midgen (pictured), index strategist at LGIM. “Commodities is often the smallest allocation to their portfolios but the most complex and this provides a neat solution for them. Assets have grown to USD183million since it launched in January 2012 and we’re pretty pleased with that.”

Indeed, the LGIM Commodity Composite Source ETF, which tracks the index, attracted around 24 per cent of broad commodity ETP net new assets in Europe in 2012.

One of the key reasons for its success is that not only do investors appreciate the expertise of LGIM as the Index sponsor – but the fact that it has been constructed on their back of their concerns, primary among them being exposure to counterparty risk.

“It’s a rules-based index that aims to solve a number of issues that investors face; they want diversified exposure to a number of counterparties not just one, they want exposure to a broad range of commodities in a simple way,” says Midgen. The index provides exposure to 30 underlying commodities over five major sectors, of which energy is the largest constituent sector with 32.7 per cent.

“We take a prudent approach to risk management and we’ve tried to reflect that in the creation of the LGIM® Commodity Composite IndexTM”.

Year-to-date the index is up 2.41 per cent.


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