Tag Archives: etf liquidity


Junk Bond ETFs-The Liquidity Debate Goes to SEC

MarketsMuse ETF and Fixed Income curators have frequently spotlighted the ongoing debates as to whether corporate bond ETFs, and in particular, junk bond-specific exchange-traded-funds pose special risks. Some argue that a liquidity crisis could unravel the high yield bond sector if/when institutional investors decide that risk of recession continues to ratchet higher, leading all of those investors to run for the exit at the same time, and in turn, causing a reverberation across the ETF market. The counter side to that thesis is that corporate bond ETFs (NYSE:HYG among them) are insulated from the risk of a catastrophe that might envelope the underlying components (the actual bonds themselves). One thing that is certain is that the US SEC is not certain, and they’ve raised the volume on this topic.

Adding light to this topic is WSJ columnist Ari Weinberg, someone who is arguably one of the best educated members of the 4th Estate when it comes to ETFs, and Monday night column deserves our kudos and sharing select extracts…Roll the tape..

junk-bond-etf-liquidity-crisisMost investors in mutual funds and exchange-traded funds probably don’t worry much about liquidity. After all, fund shares can be bought and sold easily anytime online, and trades are completed in one to three business days.

But there is another layer of trading—the trading the funds themselves do when a wave of selling by investors requires the funds to sell some of their assets—that has the Securities and Exchange Commission worried about liquidity. And the commission wants investors to be more aware of the risks it sees.

The issue is particularly pertinent for the fixed-income fund market, because assets that some of those funds hold are very thinly traded. Here’s a look at what’s involved.

Deciding between the two isn’t always straightforward. Here’s help clarifying the differences and similarities.

The SEC’s concern is that some mutual funds and ETFs might hold too many securities that aren’t easy to sell quickly. As a result, the funds might not always be able to adjust their holdings without “materially affecting” the funds’ net asset value per share, the commission said in its September announcement of proposed new liquidity-risk management rules. In other words, selling a substantial amount of illiquid securities quickly could drive down their price, resulting in a big loss for a fund, lowering its value.

Among other things, the proposed rules would require funds to categorize the liquidity risk of their holdings according to how many days it would take to sell the assets without greatly affecting their market price, and disclose those risk assessments to investors. The SEC also proposed to strengthen and clarify an existing guideline that no more than 15% of a fund’s assets should be held in securities that would take more than seven days to convert to cash.

Several ETF issuers, as well as the Investment Company Institute, a fund industry trade group, have said in comment letters that the SEC’s proposals aren’t relevant to most ETFs, because the funds are structured differently from mutual funds.

Mutual-fund investors buy and sell their shares directly from or to the fund. So mutual funds regularly need to sell assets on the open market to pay investors who are redeeming their shares. But ETF shares are traded among investors, not between investors and the fund. So most ETFs usually don’t have to sell assets when investors sell their shares, because the shares are being bought by other investors, not being redeemed by the fund.

ETF shares are only created or redeemed, and the underlying assets bought or sold, when doing so is necessary to keep the market price in line with the net asset value of the fund’s holdings. Those transactions are done between the funds and financial institutions called authorized participants, or APs, which often also serve as market makers in the ETFs and other securities.

Here is how it works in most cases: If heavy selling is driving an ETF’s market price below the fund’s net asset value, a market maker, acting through an AP or acting as an AP itself, will buy up shares and deliver them to the fund in the form of a so-called creation unit—taking them off the market—in return for an equal value of the underlying assets held by the fund. It’s then up to the trading firm to decide if it wants to hold those assets or sell them.

The argument ETF issuers are making to the SEC is essentially that this process insulates ETF investors from the dangers of a fund having to sell illiquid securities on the open market.

The opposing argument, made by the SEC and those who favor the proposed new rules, is that there is a risk that the AP might not be willing to take on assets that are very hard to sell quickly, throwing a wrench into the whole process of keeping the fund’s net asset value in line with its share price. That would be reflected in a widening of the bid-ask spread for the ETF—the difference between the price investors can get for selling shares and the higher price they would have to pay to buy the shares.

The concern that this could happen to a fixed-income ETF is based in part on changes in recent years in the fixed-income markets. Financial institutions in general are more averse to the liquidity risk that some debt securities pose, in part because of increased regulation governing the institutions’ risk exposure. Investment banks, for instance, hold 80% less corporate bond inventory than a decade ago.

Ultimately, according to many traders and market participants, concerns around ETFs and fixed-income holdings will only be mitigated when there is more transparency in the market, as more securities are quoted and traded electronically. Currently, only about 10% to 25% of the secondary trading in corporate bonds—depending on the amount of each bond in the market and the issuer’s credit quality—is electronic. The rest is done via online messaging and phone calls.

Continue reading Ari Weinberg’s dissertation directly via the WSJ


Best ETF Market-Making Award Goes To..

In coetfcomlogonnection with the 1st Annual ETF Awards hosted by ETF.com, the world’s leading authority on exchange-traded funds, agency execution firm WallachBeth Capital was selected “ETF Market- Maker of the Year” by a panel of judges representing prominent firms from across the ETF industry. The announcement was made during a gala dinner held on March 20th at New York’s Chelsea Piers and attended by more than 300 industry members.

According to ETF.com Founder and CEO Jim Wiandt, “The award to WallachBeth for market maker of the year recognizes the firm that has done the most to improve investor outcomes throughout education, support, services, innovation and outreach.” Runners-up for the category included Citigroup, Goldman Sachs, Jane Street Capital and KCG. A total of 23 categories were voted upon by the ETF.com judge’s panel.

In making the award, the ETF.com judges noted, “While many firms share credit for helping ETF investors understand ETF liquidity, few have been more dedicated to the task of educating clients and improving outcomes than WallachBeth. The prototypical agency broker, it uses strong Street connections to source liquidity for clients, allowing the world’s best market makers to compete for each order. The agency approach—where WallachBeth is always on the side of the client—resonates with advisors, who often need hand-holding when they enter the fast-moving world of ETF trading.”

WisdomTree: ETF Underlying Liquidity vs. Secondary Market Liquidity Explained (Again!)

etftrends logo imagesCourtesy of Zach Hascoe/WisdomTree Investments

We have heard it over and over: Exchange-traded funds (ETFs) are wrappers, and the true liquidity of an ETF is derived from its underlying constituents.1 While that statement is true, it does not completely explain different types of liquidity that can exist in an ETF.

Different types of ETFs can serve different purposes as exchange-traded vehicles, depending on the exposure they provide. Some ETFs are used primarily for hedging and intraday portfolio trading. These ETFs typically track major world benchmark indexes, and they trade millions of shares per day.  Other ETFs are structured more as investment vehicles and don’t typically have very high average daily trading volumes. Investors come into the products, hold their positions and eventually unwind the investment months or years down the road. While all ETFs can be held for prolonged periods or intraday, some ETFs experience more secondary market trading than others. At WisdomTree, we structure all our ETFs with liquidity screens to help provide sufficient implied liquidity (underlying liquidity), so even if the ETF has a low average daily volume in ETF terms, that does not mean the ETF is illiquid.

*MarketsMuse Editor note: Because ubiquitous trading screens often fall short in displaying actual liquidity v. what appears on the screen, institutional investors and RIAs are advised to defer to independent, “agency-only” execution firms –those who specialize in providing objective insight and the likely liquidity that exists “behind the scenes”

A recent comparison between the WisdomTree India Earnings ETF (EPI) and the WisdomTree LargeCap Dividend ETF (DLN) helps illustrate the difference between primary market and secondary market liquidity. As the industry’s first India ETF (launched in February 2008), EPI has become a popular way to gain intraday tactical exposure to India equities. For example, during the week of May 20, 2013, to May 24, 2013, EPI traded roughly $325 million of dollar trading volume on the secondary market. Yet during that week, EPI had no creation/redemption activity. There was $325 million of dollar volume traded and there were no inflows or outflows that week in EPI. That is secondary market liquidity. Investors were able to easily buy or sell EPI on the secondary market, as buy and sell orders were matched up by the broker-dealers. While new shares can be created on the primary market if demand warrants it, EPI is so widely traded by a wide variety of market participants, that often there is significant two-way trading in the ETF that happens on the exchange. At the end of the day, dealers left with inventory in EPI may decide to hold on to their positions because they are confident that two-way demand in the ETF will continue the next day. Continue reading

Attn: Pension Fund Mgrs: ETF Trading Choices Can Affect Costs and Execution

  By Ari Weinberg | November 26, 2012    

Pension fund managers considering expanding their use of exchange-traded funds must always bear in mind that trading ETFs is entirely different from trading stocks.

Entering a transaction without a clear understanding of the market dynamics for the ETF and the underlying stocks can be costly without the right precautions. The market impact can be more than the fee in basis points cited in the funds’ materials.

“The implementation of a trade is very important and, in some cases overlooked,” said Tim Coyne, head of ETF capital markets for State Street Global Advisors in New York. SSgA sponsors nearly $300 billion in U.S. exchange-traded products. Only in the past few years, with the surge in ETF issuance and trading, have market makers and institutional agency brokers begun to offer ETF-specific implementation shortfall models.

One of the selling points for ETFs is that they can be more liquid to trade than their underlying constituents, but this is only the case in a handful of funds, said Alex Hagmeyer, vice president for data analytics at Markit in Naperville, Ill.

Estimating market impact — the spread from arrival price to final price — to include the notion of ETF creations and redemptions can be complicated by market conditions. And the dynamics of ETF trading have several brokers and data analysts refiguring their implementation shortfall estimates, taking into account that liquidity in the ETF is not the same as the total liquidity available to the investor.

For pension fund managers passing through ETFs in a manager transition or when adding a liquidity layer in broad-market ETFs, market impact models may seem a distant concern but basis points on large transactions can add up.

“A lot of ETFs are quoted by market-making algorithms,” said Chris Hempstead, director of ETF Execution at WallachBeth Capital in New York. For this reason, the impulse to get filled instantaneously by sweeping the limit order book can have a negative impact on an ETF trade.

Mr. Hempstead paints a scenario of an ETF order for 10,000 shares — 1,000 shares filled at the displayed price and 9,000 a nickel away. “If the quotes fill in around your trade (back to the original price), you probably paid too much,” said Mr. Hempstead.

For the entire P&I article by Ari Weinberg, please visit Pensions&Investments online

Assessing the Merits of an ETF: Debunking Common Myths

Extract of white paper published by Chris Hempstead, Head of ETF Trade Execution for WallachBeth Capital LLC

With respect to analyzing and selecting ETFs, one of the most common and frustrating mistakes that I overhear is “..unless the fund has at least some minimum AUM ($50mm in many cases), or has average daily trading volume less than [some other arbitrary number] (say 250k shares) it should be avoided…”

Some other arguments against ETFs go so far as to suggest that “..ETFs need to have a certain history or track record before they should be considered…” Adding insult to injury is the claim that “investors are at risk of losing all their money if an ETF shuts down.”

In light of recent articles being picked up by media from New York to Seattle, I would like to dismiss a few of these common, yet unwarranted reasons to avoid an ETF based solely on AUM, ADV or track record.

 First, let’s address AUM:

“ETFs with less than $50mm should be avoided”

In order for an ETF to come to market (list on an exchange) the fund needs to have shares created. This process is often referred to as “seeding”. The ‘seeder’ is the initial investor who delivers into the custodial bank the assets required to back the initial tradable shares of the ETF in the secondary market. ETFs issue shares in what are known as creation units. The vast majority of ETFs have creation unit sizes of 25k, 50k or 100k shares.

When a ‘new’ fund comes to market, they are usually seeded with at least 2 units of the fund. There are very few examples of ETFs that come to market with more than $5mm in AUM or an excess of 200k shares outstanding. One recent exception comes to mind: Pimco’s BOND launched with ~$100mm AUM and 1mm shares outstanding.

Understanding that ETFs have to start somewhere, it would be difficult to explain how more than 55% of ETFs (excluding ETNs, Leveraged ETFs and Inverse ETFs) have garnered AUM in excess of $50mm.

In other words, someone had to take a close look and invest into the funds. The ‘I will if you will’ mentality is probably not how the most successful fund managers find ways to outperform.

Ten of the top thirty performing ETFs year to date have AUM below $50mm.


Congratulations to the pioneers who ‘went it alone’, as they say. Continue reading

Narrowing Spreads for Illiquid ETFs

Excerpts Courtesy of James Armstrong/Traders Magazine

For some illiquid exchange-traded funds, the price isn’t always right. Spreads can be unreasonably wide, luring the less informed to take the bait and accept a price that is far from reasonable. Fortunately, those spreads are slowly narrowing due to competition.

With illiquid funds, the screen does not always match what an ETF is really worth. If a fund rarely trades, both the bid and the offer will be posted by professional trading shops and will be skewed to a premium or a discount. That means spreads can be more than a dollar wide at times.

Even if liquidity is present, it’s not showing up in the posted prices. Recent data from Index Universe shows more than 10 percent of ETFs still have spreads of 100 basis points or more. The vast majority of those funds have an average daily volume of fewer than 5,000 shares.

Many in the industry are trying to help investors who want access to these lightly traded ETFs but don’t want to get soaked every time they buy or sell. Gradually, they are starting to get some of those spreads down to more reasonable levels, though certain funds still have a way to go.

High-Touch + High-Tech Approach

The agency shop WallachBeth Capital has built a niche for itself with ETFs that trade in lesser quantities. Though liquid ETFs can be plugged into algos without much of a problem, less liquid ones cannot, so WallachBeth combines high tech with a high-touch approach to its trading. The firm uses a highly-sophisticated trading technology platform to support its ETF desk of 12 traders to find liquidity that doesn’t show up on the screen.

Andrew McOrmond, managing director at WallachBeth, said if a broker only calls one or two people, and counterparties know there isn’t much competition for that order, they won’t get the best price. But when a firm calls 22 people, he said, and their counterparties are aware of this, firms on the other side tend to give their best price rather than dangle an outlier number in hopes of catching a big spread.  Continue reading

NASDAQ New Rule: ETF Issuers Can Pay Market-Makers Quoting “Thinly-Traded” products


As duly noted by industry expert TABB Forum, ETFs with little-known or illiquid underlying securities are a hard sell without liquidity.  “Whether you loved or hated them, major exchange specialists (including this blogger) played a vital role to help nurture small listings, and the problem of how to incent liquidity provision is an ongoing industry debate. Without an extra incentive, market makers don’t consider it worth the risk..”

NASDAQ apparently understands this challenge. As reported by TABB, and in a rule filing submitted to the SEC, the exchange that will soon be home to Facebook proposes to put ETF issuers in the driver’s seat by facilitating issuer payments to market-makers in consideration for those traders quoting and trading those pesky, “hard-to-trade” aka “illiquid” ETF products that seem to trade by appointment only.

According to the TABB piece, “..The rule filing is waiting to be ‘noticed’ by the SEC, which will start turning the wheels of the rule filing and formal commentary process. If ultimately approved, the writing is on the wall for equities.There is little on the regulatory table at the moment to improve market quality, but prior success of a similar program abroad and political concern over how to improve the lot of smaller securities at least gives this proposal a decent chance of making it to the pilot…”

Not everyone fully agrees. At least one former ETF market-maker who was invited by NASDAQ to help formulate their new proposal believes it could open Pandora’s box (even if some think the Genie is already out of the bottle..) Continue reading

Hearing is Believing: ETF Best Ex Expert Says…

As US equity indexes search for a trading session bottom from which to bounce today, traders are slamming their phones in frustration when discovering the screen markets are as clear as a very cloudy day. Nothing new on that front..as ETF market experts will repeatedly repeat “don’t expect to find deep liquidity on the screens, expect to find it courtesy of connectivity..”

To hear it from the horse’s mouth, this BloombergLP-inspired podcast with Chris Hempstead, head of ETF execution for WallachBeth Capital is a good listen. Click this link: ETF Liquidity Interview

Expert ETF Trader: Liquidity Is There; Just Look Beyond the Screens

Other than the ETF market “go-go names”, one of the more commonly-voiced, and according to many, often-misguided observations regarding most ETFs is  “won’t trade it, there’s no liquidity in that name,”  or “the screens are only showing 1000 shares offered and I have to pay up 50 cents to buy a lousy 25,000 shares?!”

As a consequence, any half-smart portfolio manager often quickly (if not wrongly) concludes that the “lack of liquidity cost” is a deterrent to their positioning what is otherwise a very compelling “basket” of underlying securities.

The editors here don’t buy into the lack of liquidity notion, and after getting our hands on desk notes published today by Chris Hempstead, Head ETF Trader for WallachBeth Capital (one of the more prominent players in the ETF space), we couldn’t resist the opportunity to re-publish.

But wait, there’s more!