The Wall Street Journal featured an interesting piece titled “For some Investors, Night of Living ETF.” Here are some highlights:
Low costs are a selling point for the exchange-traded-fund industry. But more than a quarter of the ETFs on the market are hitting shareholders with high trading costs that escape many investors’ notice.
These ETFs typically have relatively few assets and low trading volume, but they still total nearly $8 billion in assets.
“Individual investors losing out: That’s the risk with this zombie underclass” of ETFs, said Matt Hougan, director of ETF analysis for IndexUniverse.com. “People will have bad experiences.”
Many of these ETFs still are young and may trade more smoothly if they can attract more assets. But many established funds, like the two-year-old, $2.9 million Claymore/Morningstar Information Super Sector Index, still are small. And some of those that have attracted substantial assets, like the $438 million SPDR S&P; Emerging Asia Pacific, still carry significant trading costs.
The ranks of less-liquid ETFs are expanding as money available to seed new ETFs dries up but fund companies continue to roll out new products. Though many funds don’t attract much cash, they are relatively cheap to launch so fund companies will continue to throw products at the wall to see what sticks, ETF analysts said. There are more than 500 ETFs in registration, waiting to be launched.
What concerns me far more than direct costs is low trading volume. Some of the ETFs featured in the ETF Master list of my StatSheet are featured to show all the different types that are available, but that does not make them necessarily a good choice.
Once you have decided on an ETF invest in (via momentum index selection or other criteria), you need to look at volume. For quick reference, I use Yahoo Finance. Let’s say, I want to check out the particulars for QQQQ (in which we currently have positions), I simply go to this link and immediately can see that the average daily trading volume is over 113 million shares, which makes it very suitable even for large block trades.
How much volume should you be looking for in an ETF? To me, the very minimum is about 4 times the amount I am planning to invest. Say, I want to deploy $2 million of clients’ assets, I want to see an average daily volume of at least $8 million. That assures me a fairly smooth fill without too much slippage.
More importantly, looking ahead, the time will come when the trend reverses, and I’ll be heading for the exit door. I want to be able to get out as quickly as I can and with as little of a price concession as possible.
You can only do that by being invested in high volume ETFs. I suggest you use a similar approach by making a quick volume check before entering your order. In a way, investing in a low volume ETF can increase your hidden costs by decreasing your exit price and thereby lowering your accumulated profit or, in some cases, increasing your losses.
Comments 7
Thanks for the article on buying/selling ETFs. I had no idea that volume affected the profits when the ETF is sold. It's nice to have your wisdom keeping me from making more mistakes. Great article.
Not relating to this particular post, but……..
Just as trends and moving averages can TELL us when to get in or out, crowd psychology can give us insight into tops and bottoms. You can't get any more pessimistic than people (the media) was back in March '09.
I highly recommend Against the Gods, a book about risk, and The Black Swan, a book about unforseen, unknowable events.
And for everyone looking at charts of the Great Depression and 1929-1933, just remember that it is human nature to try to look for patterns in things that may very well be random. It makes humans feel better if they think they can "figure things out", or know what's going on, or is going to happen.
Be well, and keep spending, for this is no other real option : )
Ulli,
These new ETFs are like a run away train totally out of control. Investing is already complicated enough and now there will be hundreds more choices out there. When it is all said and done really all most of us need are the following 4 one beta long ETFs like QQQQ, SPY, IWM, and maybe at times EFA as well as a couple of one beta short ETFs like PSQ and SH. If only two ETFs were to be used I would go with VXF long and SH short for myself. All these would be used at the appropriate times during each trend timing market cycle. Thanks Ulli for getting back to more basic investing topics and thanks Ulli for the free letter each week and this blog that you provide for our learning experience, which is much appreciated.
Low volume is not the same kind of problem for a small investor who is only buying or selling a few thousand dollars at a time.
The problem in thinly traded ETFs or stocks is that the spread between the bid and ask price is so high.
With SPY the spread is only about 1¢, but for some ETFs or stocks the spread might be 10¢ or more, which gouges you both when buying or selling at the market.
I like SPY because of the diversity across all industries. The majority of the money is in only the top 30-40 companies, but they are huge, successful companies in at least seven or eight totally different industries.
I also like SPY because it is less volatile than trying to track the current "hottest" funds, whatever is in style in a bull market, growth, mid cap, whatever. With SPY even when the sectors rotate in favorability, you're still sure to have a representative sample.
Less volatilty enables me to stay with the trend longer, concentrate on following one major index that is reported everywhere, and have a good idea of what companies the majority of my money is in.
Yes, I won't get the super ride to the moon that I wanted when I was back in my 30s and early 40s, but I also have much less of a chance of getting stopped out or whipsawed.
What I learned, was that ETFs now account for 43% of the market's volume, even though they don't usually pay any dividends. I think they are like any equity — low volume for each one is dangerous. I think anything with an average volume of below a million shares trades a day is dangerous, whether it is a stock or an ETF. Otherwise, there is not enough trading happening to move the stock or the ETF one way or the other in a fairly predictable manner. I think it is good, also, to know that stock brokers hate ETFs; most brokers think that ETFs are "freeloaders" on the market and do not do anything to justify their existence. Most brokers think that ETFs don't help companies generate capital to expand. Perhaps they're right, but in my experience, brokers have looked out for themselves rather than looked out for their clients, so I don't worry about what they think very much. If ETFs can make investors money, I am for them. Your article was good, Ulli; volume is very important.
Also, ETFs do purchase stock in companies, so they do generate capital in companies, except in bear markets. Then, they are great, if you want to stay in the market and take your chances, to make some money, whereas stocks are terrible investments. Of course, a more conservative approach, in a bear market, is your stop loss approach, Ulli, as bear markets can be, well, bears.