Most Popular ArticlesSeptember 15, 2009
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An ETF does not require a certain amount of trading volume in order to be liquid. The underlying securities of the ETF determine its liquidity. Many within the industry do not grasp this reality and are missing out on a lot of quality ETFs.
When evaluating the quality of an ETF offering or its suitability for a client, the issues of trading volume and liquidity come up often. Due to a general shortage of information on of the nuances of ETFs and a lack of education about ETFs in the investment advisor community, these issues have become driving forces in determining which ETFs are best tailored for client portfolios.
The ETF industry is guilty of misleading institutional investment managers, investment advisors, and individual investors. Registered investment advisors and institutional money managers have offered me accounts of ETF-provider sales representatives explaining very little about their products or the investment strategies, and simply declaring, “Volume matters! Case closed.” The often-repeated “volume matters” statement has become one of the most misused and abused notions in the ETF industry. Articles and blogs proclaim that when evaluating ETFs one should exclude those issues with less than 100,000 shares of average daily trading volume. This forces the investor or portfolio manager to wear blinders and severely narrows the universe of acceptable ETFs to consider.
Rules like “investing only in ETFs that trade at least 100,000 shares” daily will filter out dozens, if not hundreds of potentially powerful and effective investment products. Trading volume is important, but it’s not the driving force that makes products ultimately successful for investors. The positive results that ETFs can create for investors within their portfolios should be the only story that matters.
From a fund provider standpoint, if the majority of the trading volume in ETFs is new buyers, that is an excellent sign for the viability of the firm. Many frequently traded ETFs go days or months with the majority of the volume being made up of sellers or short sellers, and this punches holes in the system of evaluating the merits of an ETF on trading volume alone. If we blindly assume that the most frequently traded ETFs were the best ETFs, we would be forced to assume that the mutual funds with the highest level of net redemptions are also the best mutual funds, since they have the most trading associated with them. This is simply flawed thinking.
All ETFs not are created equal
The first line that needs to be drawn is that not all ETFs are the same. I will focus on equity index ETFs, long-only investment products that invest in a defined index made up of equity securities. Over the years the ETF industry, has moved from offering from plain vanilla index ETFs that track the S&P 500 or the Russell 2000 to products that are either commodity linked (tied to Oil futures, agricultural products, platinum, etc.) or use leveraged or inverse strategies. Because these subcategories of ETFs are not all the same, using broad, sweeping statements like “trading volume matters for all ETFs” is an overly simplified and imprudent way to evaluate ETFs.Display article as PDF for printing.
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