It feels like only a month ago that I was on a client call and highlighting that the typical spread in one of our exchange-traded funds (ETFs) was 2-3 cents wide, and that they should feel comfortable buying and selling multiples of the average daily volume, most likely within the bid/ask spread. We had case studies to back this up! My, how times have changed.
Everyone’s focus should rightfully be doing whatever possible to get through this coronavirus pandemic and certainly washing hands and staying at home are far more important than any discussion on ETF trading.
We are all adjusting to the current world of limited public gatherings, closed schools, canceled sports and empty airplanes. It is very possible that this “new normal” lasts for months, not weeks. Thus, it might be time to make some adjustments to how we normally think about ETF trading and liquidity.
Our usual trading best practices around avoiding the market open and using limit orders still apply, but now let’s add one more step we believe to be crucial for ETF trading given the current market environment.
If bid/ask spreads in an ETF are wider than you are accustomed, do not panic! Simply call/email the ETF issuer’s capital markets desk and/or your ETF liquidity provider of choice, and they will help guide you on the expected price you could buy or sell your ETF.
A wider spread is not an ETF liquidity failure! In normal times, the spread is indicative of where ETF market makers would risk their capital. These are not normal times! Given the recent extreme market moves, it is not surprising that they are erring on the side of caution with their bid/ask spreads in case the market moves faster than they can adjust their quotes.
For newer funds with smaller average volumes, think of it as reversing the usual order of events. Normally, the ETF market makers show their supply on exactly where investors could transact (via tight spreads). Now, ETF trading is much more ‘”on-demand” as they wait to facilitate both buys and sales from their clients. They can do this both electronically via RFQ (request for quote) platforms or manually via the phone.
The ETF liquidity is still there…you just may need to take an extra step of asking to see it.
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What Are the Risks?
All investments involve risks, including possible loss of principal. Generally, those offering potential for higher returns are accompanied by a higher degree of risk. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. For actively managed ETFs, there is no guarantee that the manager’s investment decisions will produce the desired results.
ETFs trade like stocks, fluctuate in market value and may trade above or below the ETF’s net asset value. Brokerage commissions and ETF expenses will reduce returns. ETF shares may be bought or sold throughout the day at their market price on the exchange on which they are listed. However, there can be no guarantee that an active trading market for ETF shares will be developed or maintained or that their listing will continue or remain unchanged. While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.
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