This is a review of a session from the Money Management Institute’s 2012 Fall Solution Conference. This is part two of a two-part series. You can read part one here.
- Benjamin T. Fulton, Managing Director of Global ETFs, Invesco Powershares Capital Management, LLC
- Sam Turner, Director of Large Cap Portfolio Management at Riverfront Investment Group
- Jill Iacono Mavro, Managing Director, Head of National Accounts, State Street Global Advisors – $337 billion in ETF assets globally, 94% in US, SPY launched in 1993
- Dodd Kittsley, Senior Product Manager & Head of ETP Research, iShares
How much weight should advisors put on liquidity when evaluating an ETF?
There are two levels of liquidity: primary and secondary markets, Mavro said. On the primary market, an ETF is as liquid as the underlying index that it tracks. It depends on how easy is it for authorized market participants to trade the basket of securities that represent the index. On the secondary market, liquidity is defined by how often the ETF is traded. The more it is traded, the thinner the spread between the bid and ask prices. Advisors should look at both levels together, not just one or the other.
Turner disagreed and stated that primary market liquidity and fees are the two worst reasons to select ETFs. Riverfront focuses primarily on exposure and have never had an issue getting out of an ETF due to lack of primary market liquidity, he said.
Secondary market liquidity can become an issue when investing ETFs according to Michael Jones, also from Riverfront Investments, who was in the audience. He provided an example where Riverfront was the seed investor for an international ETF that was currency-hedged (The ETF happened to be DBX MSCI EAFE Hedged Equity Fund, symbol: DBEF). Primary market liquidity wasn’t a problem for them since they were working directly with the authorized participant and had great execution. However the use of the currency hedge became more and more expensive to the point where they had to pull their investment due to the high marginal trading costs of bringing on each additional client, he said.
Should You Avoid ETFs with Low AUM?
An article in Barrons makes the case that low AUM is not a good liquidity indicator for ETFs:
“…asset levels aren’t always the best proxy for liquidity. Unlike a stock, an ETF can still have strong liquidity even if its trading volume is low or its assets are tiny. That’s because the underlying stocks’ or bonds’ liquidity is usually the best way to measure an ETF’s real ease of trading. Barron’s asked market-making firm Knight Capital to rate the liquidity of 30 small ETFs whose 2012 returns are about double those of the S&P 500 as of early November. If you judge ETF tradability by the way its components trade, as Knight does, you’ll find lots of low-asset ETFs with more-than-expected liquidity. “I wouldn’t shy away from ETFs that have low volume or low assets. You just have to be smart about how you trade it,” says Eric Lichtenstein, managing director of Knight’s ETF trading desk.”