“ETF units are created by the exchange of the stocks in the fund, with the same value of ETF shares going back out to the marketplace,” Laidlaw says.
“The ability of the market maker to deliver those shares to Vanguard also supports the liquidity of the product.
“So there’s two layers. Advisers should remember there’s this other layer.
“Liquidity is important, because it’s the ease with which investors can get into or out of an investment.”
Laidlaw says that with any investment product,“advisers ultimately want to know, can my clients get into and out of this product?”. “During the GFC, things we thought we could get into and out of easily, that wasn’t the case.” But even international ETFs listed on the ASX tend to be “very big funds” that track highly-liquid indexes.
Baker says a key challenge for any ETF provider is to make sure the bid/offer spread remains tight. In the early stages of ETF development, spreads tended to widen, and that meant buyers were sometimes paying above NTA to get into the ETFs, and receiving less than NTA when they sold – the very shortcoming of the LIC structure that ETFs were meant to overcome.
He says there are a number of factors that influence the spread. One is the nature of the assets the ETF invests in, and that’s determined by the index that the ETF is built to track.
Russell’s Skelly says that ETFs that track indexes comprised of large, liquid securities tend to have relatively narrow spreads. ETFs that track indexes made up of less liquid securities (including equities in emerging markets) tend to have wider spreads.
“The more liquid, the better [narrower] the spread, generally,” she says.
“People are concerned about, can I get my money out if I need to? It is [dependant] on the underlying liquidity. The second question is: Do I get the price I want?”
Baker says spreads are also affected by whether the ETF that an investor buys invests in the market of their home country.
“Whenever anyone is making a market and taking a risk, that’s got to be reflected in the spread”
“One of the big challenges has been for cross- listed ETFs,” Baker says. “That’s where the ETF is domiciled somewhere else, and it’s cross-listed here. The assets are being managed somewhere else, in a different time zone – that’s the important part.
“One of the challenges that iShares experienced, in particular, [was that] its ETFs were foreign ETFs and during our trading day most of those are closed. Therefore the market makers have a bit of a risk because if people are buying and selling markets during our day, they [the market makers] can’t actually move on that until the next trading day opens.
“That means they are not going to run as tight a spread as they would for a locally-managed ETF. Certainly in the early days there were some real issues around the spreads in those iShares ETFs.”
Laidlaw says Australian-listed ETFs that invest in offshore markets will always have greater pressure on their spreads.
“For some of the international ETFs – which are trading during Australian hours, but investing in the US market, for example – what we’re seeing there is there’s less ability to know with such certainty what they’re worth, because the US market is shut,” Laidlaw says.
Futures markets give authorised participants and market makers some idea of what the US market is likely to do when it next opens, but it can never be completely accurate.
“Whenever anyone is making a market and taking a risk, that’s got to be reflected in the spread,” Laidlaw says.
Great job Simon, very imformative. The hard thing I find wth ETFs however is transparency of the bid/offer spread. You might be 2% behind when buying even though the market maker is supposed to be as close as possible to the NAV.