CONTRIBUTORS
David Mann
Head of Global ETF Capital Markets, Franklin Templeton
David Mann revisits the ever-popular topic of liquidity in exchange-traded funds and posits sometimes taking risks in life can be worthwhile.
It is hard to believe we just celebrated the three-year anniversary of our Capital Markets Corner blog! Over that time, we have posted more than 50 articles on a wide array of topics including exchange-traded funds (ETF) trends, trading best practices, misconceptions, US market structure and regulatory changes.
My very first post was titled, “What Investors Look for in an ETF.” In fact, my whole initial series of blogs focused on some of the main misconceptions related to ETF liquidity, a topic that always comes up when discussing ETF trading, even today.
Admittedly, back then I knew what was in store for our lineup given we were a newer entrant within the ETF space. Generally speaking, newer funds are smaller, volumes are lower and spreads are wider. The challenge was proving that even if the counting stats were lower, investors could still trade those funds easily (and they can!).
And guess what? It has been very challenging getting some investors on board.
Investors want ETF liquidity, and often make investing decisions based solely on a fund’s liquidity profile. What I did not fully appreciate as we first launched our products is that there are two distinct camps of investors who want ETF liquidity, for what I think are two completely different reasons:
1) They Want Strength in Numbers.
Some investors like high average volumes because of the optics of bigger numbers being better and the added comfort of knowing that lots of other people are using/trading a certain ETF. Going with the crowd can feel like the better and safer choice. This phenomenon is not just an ETF issue.
For example, I will admit that there are times I choose a restaurant based on the number of people eating there. In fact, a new restaurant opened up near my house that checked all the boxes: great menu, nice décor, solid selection of beer. But the first couple of times I walked by, it was usually empty so I avoided it. But guess what? My wife and I finally gave it a try, and it was great. And guess what else? It is now starting to get crowded. I am pretty sure there is an ETF lesson in there somewhere.
If you’re not a foodie, perhaps a quote from hockey legend Wayne Gretzky would resonate: “You’ll always miss 100% of the shots you don’t take.”
2) They think it will equate to reduced trading costs.
These investors gravitate to higher-volume ETFs because of the perception that it is easier to enter and exit a position. Put another way, there is a perception that higher volumes and tighter spreads result in lower trading costs. That is not necessarily the case, and is a topic I have discussed in this forum repeatedly.
I talked about it from the bid/ask spread angle in these posts:
I talked about it from an ETF arbitrage/underlying basket angle in these posts:
- About Arbitrage
- Expanding on Arbitrage Bands
- A Voluminous Responsibility
- Trading, Arbitrage and the New ETF
- The Deceiving Penny
Three years later, I feel confident we are making progress in addressing the second point above. Furthermore, repeated trading conversations with all parts of the ETF ecosystem—investors, market makers, authorized participants, exchanges—have helped identify concerns and create possible solutions.
As an example, we have implemented several innovative trading programs that we feel have greatly improved the liquidity in our funds to the point where the trading experience (and costs) in our funds should be no different than in those with higher volumes.
The comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.
This information is intended for US residents only.
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. Bond prices are affected by interest rate changes. Bond prices, and thus a bond fund's share price, generally move in the opposite direction of interest rates. As the price of bonds in a fund adjusts to a rise in interest rates, the fund's share price may decline. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments; investments in emerging markets involve heightened risks related to the same factors. To the extent the fund focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a fund that invests in a wider variety of countries, regions, industries, sectors or investments. Smaller, mid-sized and relatively new or unseasoned companies can be particularly sensitive to changing economic conditions, and their prospects for growth are less certain than those of larger, more established companies. Historically, these securities have experienced more price volatility than larger company stocks, especially over the short-term. Performance of the funds may vary significantly from the performance of an index, as a result of transactions costs, expenses and other factors. For smart beta ETFs, there can be no assurance that a fund's multi-factor stock selection process will enhance performance. Exposure to such investment factors may detract from performance in some market environments, perhaps for extended periods. For actively managed ETFs, there is no guarantee that the manager's investment decisions will produce the desired results. These and other risks are discussed in the fund’s prospectus. ETFs trade like stocks, fluctuate in market value and may trade at prices above or below their 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, not their Net Asset Value (NAV), on the exchange on which they are listed. Shares of ETFs are tradable on secondary markets and may trade either at a premium or a discount to their NAV on the secondary market.
For more information on any of our funds, contact your financial advisor, download a free prospectus or call us at (800) DIAL BEN/342-5236. Investors should carefully consider a fund's investment goals, risks, sales charges and expenses before investing. The prospectus contains this and other information. Please read the prospectus carefully before investing or sending money.