CONTRIBUTORS
David Mann
Head of Global Exchange-Traded Funds (ETFs) Capital Markets, Franklin Templeton
Is it time to give newer or smaller exchange-traded funds (ETFs) a look? David Mann, our Head of Global ETFs Capital Markets, makes the case as he opines on his favorite subject—liquidity.
Has it really been a year? Normally I would make a comment about how “time flies,” but am pretty sure that is not the case for most folks (including me!). We just hit the one-year anniversary of the market turmoil and madness caused by the global pandemic. I am not sure I even enjoy re-reading my posts about the impact of market uncertainty on ETFs or the strain it can put on the ETF arbitrage mechanism.
Global markets seemed to have calmed down since a year ago, with many once again near their all-time highs. Many of our conversations about ETF liquidity have also returned to normal. Unfortunately, nuanced questions about how an ETF could trade like a closed-end fund under extreme market stress have faded into the background, replaced with the usual “what’s your spread?” and “what’s your average volume?” I am going to save my thoughts around using pure stock metrics for a hybrid stock/fund vehicle for my next post.
I have been thinking a lot about “time” over the past year. This is now the longest amount of time in which I have not seen my parents or siblings. Now that my commuting time has been reduced to zero, I now have more time to exercise. I now spend a lot more time with my family (which I think has been a good thing!).
Time has also been creeping into how I think about ETF liquidity. We recently had a couple instances where there was some (I would like to think) serious interest in one of our smaller funds. In one case, the interest was in one of our low-cost passive funds, and in another it was one of our active fixed income funds. In both cases, they went with a higher volume fund because it was “more liquid.” I am sure many other ETF issuers have experienced something similar.
But I would like to think that “liquidity” is not really the issue. I estimate that half of my 60+ blog posts over the past five years have discussed ETF liquidity in some form. I have a briefcase full of examples of efficient trading in our funds, and am sure many of my capital markets friends at other ETF issuers have the same. There are ETF market makers on standby who would efficiently trade any ETF, irrespective of its volume. I would like to think when it comes to the ETF liquidity education battle, we are making some real progress.
So, what is the issue preventing more adoption of smaller funds? I would argue “time” is just as likely a reason. If an investor normally uses market orders, it might take time to understand the typical spread and what limit price to use within that spread. If the fund is brand new, it might take time to research which market-making firm has seed inventory and thus might be motivated to sell. The liquidity is there—it just might take a little extra time to find it.
I have been thinking about this a lot in relation to my everyday life and for the most part, I think I usually do spend the extra time. While one large airline might have the most flights to my preferred destination, I will always check multiple websites in search of the best fares—both in terms of price and convenience. While one large national sandwich chain might sell the most subs, if I want a gourmet sandwich from the local shop at noon, I can call them ahead with my order and it will be ready for me. More recently, I have even been checking multiple web sites when making online purchases , as often there are better options than just the largest or best-known one.
Hopefully, this past year has caused a few of my readers to take the extra time to give those newer ETFs a look. Their liquidity is there if you willing to take a couple minutes to find it. If you can’t, just call me or reach out on LinkedIn!
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. 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.
The companies and case studies shown herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton.