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business newsETFs and ETNs With Little Volume But Big Returns, Part 2
This year marked the beginning of a turning point for the industry as a whole; portfolio managers and investors alike are realizing that liquidity is not a requirement for success.
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Part 1 of this series highlighted ETFs and ETNs that have generated eye-opening performance over time but likely suffer from lack of investor interest due to relatively low average daily trading volumes and embedded misconceptions among the investing public (on both retail and institutional levels). Since March, has the world of ETF investors scrapped misconceptions in regard to effectively trading large volumes in relatively thinly traded products? I'd say the answer is “no,” but strides are being made in the correct direction thanks to continual education about the ETF/ETN product structures from the ETF issuers and effective measures of executing large trades in lightly traded ETFs by ETF-centric trading firms.
(For more on ETFs, try a free trial of the Grail ETF & Equity Investor.)
As Matthew MacEachern, portfolio manager at Florida-based Emerald Allocation Strategies, puts it, “ETFs do not require a certain amount of trading volume or average volume to be liquid. Liquidity of the underlying securities in the ETF will determine its liquidity. The idea that "Volume Rules" is misguided and misinformed. The good news is that this misinformation can create market inefficiencies which can be capitalized on.”
Michael McClary, CIO of Valmark Advisers in Ohio, adds, “Execution is much deeper than just trading volume and spreads. ETFs have a complete second level of liquidity, made possible by the ability of ETFs to issue new shares on the fly.” He elaborates, “If they dug a little deeper, I feel that many investment managers would find that many of the trades that they feel are an issue are actually N.O.P., or normal operating procedure”
All of this being said, there are still “screening metrics” that appear from time to time in the ETF media or are simply part of an institution’s or an advisory firm’s “rules of thumb” that “require” that ETFs/ETNs trade
a) 100,000 shares on an average daily volume basis
b) Have a certain level of AUM within the fund, i.e. $100 million and
c) Have to adhere to a specific width between the published bid/ask quotes.
We at Street One Financial find that because there is such a bevy of ETF/ETN products in the universe (equity, fixed income, commodity, actively managed, currency, long/short, etc.), rules of thumb such as those above aren't consistent with reality and often limit the strategies available to the ultimate end user of the ETF/ETN. In essence, these “rules” address ETFs and ETNs as if they were individual small-cap stocks from a feasibility-of-trading standpoint and the practice of installing such screens is akin to investing with “blinders” on. And in a world of increasing ETF usage, limiting strategies due to embedded misconceptions regarding trading volume and liquidity simply handcuffs overall performance and competitive ability because, in order to keep pace with peers, one must often venture into new strategies as they become available or at least have the capacity to be nimble where necessary.
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