One of the founders of the largest physically backed gold ETFs explains how the security functions.
“Structure Matters,” by Dan Weiskopf, portfolio manager of Access ETF Solutions, examines issues about ETF structures in a series of interviews with ETF portfolio managers, index developers and other people who affect the structure of ETFs. The goal of the series is to highlight the different operating roles that individuals have that make the ETF structure work well for the investor.
In this installment, Weiskopf interviews George Milling-Stanley. Before establishing his own consulting business, Milling-Stanley served as managing director of government affairs at the World Gold Council, where he was responsible for all programs involving central banks, governments and regulatory authorities. He was a key member of the small team that pioneered and launched SPDR Gold (GLD | A-100),which included the development of the creation and redemption structures that allow physically backed gold exchange-traded funds to function.
Dan Weiskopf: What is the investor in GLD actually buying? Does the investor own gold?
George Milling-Stanley: When you buy GLD shares, you’re buying an ownership interest in a trust, and the sole asset of that trust is physical allocated gold bullion bars. The individual investor does not own the gold that backs the trust, any more than an investor in GM owns a car or an investor in Apple owns an iPhone.
What the investor in GLD owns is an asset that tracks movements in the gold price, minus the very small costs of administering the trust. For many investors, buying GLD shares is the most cost-effective method of gaining exposure to the gold price.
Weiskopf: Tell me about the custody arrangements for the underlying gold. How does the gold that backs GLD get into the vault?
Milling-Stanley: When one of the authorized participants (AP)—the broker-dealers that make a market in GLD shares—receives an order to buy GLD on behalf of a customer, he will typically buy the relevant GLD shares on the New York Stock Exchange and fill the customer’s order.
If the AP needs to create new GLD shares, he buys an equivalent quantity of gold bullion, arranges to take delivery of that gold at the HSBC vault in London, and transfers ownership of the gold to the GLD Trust. The GLD custodian deposits the new gold into the trust’s allocated account, and the GLD trustee instructs Depository Trust Co. to create the appropriate number of new GLD shares and issue them to the AP.
No cash changes hands, apart from the small creation fee the AP has to submit with his order. None of the organizations responsible for administering the GLD Trust has to buy gold at any time, and the gold backing GLD shares is not subject to any derivative transactions, nor is it encumbered in any way.
GLD’s gold is held in an allocated account, and it is not lent out or placed on deposit at any time. In fact, because it’s held in an allocated account, the gold backing GLD does not appear on the books of the custodian at all—it is at all times the unencumbered property of the GLD Trust.
Weiskopf: Why did the sponsors of GLD choose the structure of a 1933 Act grantor trust, rather than a 1940 Act investment fund?
Milling-Stanley: That decision was dictated by the laws governing investment funds in the U.S. To qualify as an investment fund under the 1940 Act, which governs for example mutual funds, a fund has to demonstrate a degree of diversity in the assets it invests in. The GLD Trust invests in only one thing—gold bars—and so it would not qualify under the 1940 Act.