(Dow Jones) For all the talk about the runaway success of exchange-traded funds, there's at least one sector where traditional mutual funds maintain their supremacy: commodities.
Over the past year, commodities mutual funds have proportionally seen roughly five times the net inflows of commodities ETFs. By comparison, over the same period, stock mutual funds saw around three times the net inflows of stock ETFs on a proportional basis.
There is one notable exception: the precious metals subsector, where ETF flows dramatically outstrip those of mutual funds.
Data from fund-tracker Lipper Inc. shows that 94 mutual funds in the broad commodities space saw $11 billion in net inflows, compared to $1 billion for 54 ETFs. Meanwhile, the 25 precious metals ETFs have seen close to $8 billion in net inflows, compared to 74 like-minded mutual funds that have reaped $3.7 billion.
The reason for broad commodities mutual funds' popularity, say professional investors, is largely due to the fact that similar commodities ETFs hold futures contracts. This leaves ETFs more prone to so-called contango effects, as well as vulnerable to tax hits and front-running. Precious metals ETFs, however, avoid these problems by directly owning their underlying commodities.
Commodities ETFs usually hold futures contracts because the indexes they track are typically made up of contracts. But this can lead to problems, as the ETFs have fallen victim to contango--when a fund loses money every time it rolls over from a near-month contract to a further-dated contract.
One notable instance was when contango hit U.S. Natural Gas ETF (UNG) in 2009.
Mutual funds, such as Pimco Commodity Real Return Fund (PCRDX), typically gain exposure to commodities through debt instruments such as swaps and pre-paid forward notes, rather than futures, and so avoid the worst of these problems.
"Swaps and notes are more efficient and flexible to use than futures contracts," said Kathryn Young, fund analyst at investment researcher Morningstar Inc.
Vulnerable ETF
Commodities ETFs can also suffer because of their transparency-the roll-over dates of their contracts are known by the market.
"The ETFs are so transparent that they were easily gamed," said James Shelton, chief investment officer of Houston-based invest Kanaly Trust, which manages $1.6 billion for clients. "Mutual funds have done a better job of hiding what they're doing."
Shelton said he also prefers commodities mutual funds because many commodities ETFs are fairly new.
"Mutual funds have a better track record of performing across different markets," he said.
Figures from Morningstar show that about half of all commodities ETFs have been launched since early 2008.
James Dailey, chief financial officer of Team Financial Managers, a Harrisburg, Pa.-based investment adviser, noted that many of the new funds are still gathering assets so liquidity can be a concern for investors.
Dailey, whose firm manages more than $125 million, said that because commodities ETFs hold futures they also have tax liabilities, of both the capital gains and mark-to-market variety.
Precious metals ETFs hold their own
The lack of futures contracts makes precious metals ETFs so alluring. These funds, including SPDR Gold Trust (GLD), iShares Silver Trust (SLV) and iShares Gold Trust (IAU), actually hold the commodities rather than futures contracts.
"There are fewer issues to worry about when you're physically holding the material," said Dailey. "Basically there's zero tracking error to the price and it's very liquid."
"It's as direct an investment as it can be, short of buying gold itself," said Shelton.
Tom Roseen, senior analyst at Lipper, said that the previous metals ETFs may also be popular because for many investors they can serve as a short-term hedge against other parts of the market.
"You can get in and out quickly," he said.
Roseen also suggested that some investors prefer commodities mutual funds because they can provide active management.
Dailey said he didn't necessarily choose commodities mutual funds because of the active management component, but acknowledged that active management does play a role in some of his firm's decisions.
For example, Team Financial Managers is replacing its holdings in Market Vectors Junior Gold Miners ETF (GDXJ), a fund that tracks small-cap mining companies, in favor of one or two mutual funds, he said, because of better risk-adjusted returns that the actively managed funds offer.
"With small miners the management of the company is very important, and you want a fund that chooses carefully, rather than one that exposes you to the whole index," he said.
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