Top Managers Find Better Ways to Trade Tiny ETFs

By Murray Coleman

Heading into this month, just 25 funds held 61% of all the assets in U.S.-listed ETFs–and there are more than 1,458 on the market right now, according to investment researcher XTF Global. That herd-like mentality is credited by analysts to an emphasis–some say an overemphasis–on size and liquidity.

A growing number of ETFs focus on smaller niches and esoteric themes, which could be useful in a portfolio but their bid-ask spreads are often wider because they hold fewer assets and trade less often.

“There is a common misconception that if an ETF is trading at relatively low volume levels and isn’t a leading asset gatherer, it’s best to stay away,” says Alec Papazian, a strategist at Cerulli Associates who has studied such issues.

Size is relative, and prices are often more competitive than they might seem at first glance, says Doug Sandler, chief equity officer at RiverFront Investment Group in Richmond, Va. “Basing a decision purely on an ETF’s liquidity and size is one of the dumbest investment moves anyone can make,” he asserts. “Market makers often don’t spend their time publicly streaming quotes of ETFs with low liquidity,” he says. “We’ve found that working with a specialist to source better deals has been a powerful tool.”

Brad Thompson, chief investment officer at Stadion Money Management in Watkinsville, Ga., agrees. The firm, which manages $5.5 billion in assets, figures its average ETF spread nets round 0.20% across all types of funds.

Stadion’s managers say they’ve been able to trade in larger volumes and significantly narrower spreads for ETFs tracking bond markets as well as alternative asset classes. In the past, such trades have included: the iShares Barclays Agency Bond (AGZ); the iShares S&P Global Timber & Forestry (WOOD); the SPDR S&P Emerging Europe (GUR); and the iShares S&P North America Technology Sector (IGM).

“If you’re a professional adviser and money manager, there are ways to use your firm’s asset base to leverage better trades,” says Chris Hempstead, a director at execution specialist WallachBeth Capital in New York. “The so-called ‘top of book’ price you see on a computer screen, representing the best bid or ask price as disseminated by the exchanges, is just a starting point.”

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