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