When we research ETFs, we spend a lot of time thinking about costs. The passive price war has been raging for years and has taken no prisoners. But by scrutinising an ETF’s ongoing charge there is a danger in neglecting a vital part of the cost equation – liquidity.
Liquidity determines what the trade costs. Liquidity is not a subject unique to ETFs – indeed ETFs have fared well compared with the turmoil in property funds after the EU referendum – but they face their own unique issues.
For ETF investors, the key element of liquidity is bid-offer spread – the difference between the ETF’s buying and selling price. It is an important element of the total cost of owning an ETF – here are some simple steps you can take to make sure you get a good deal.
Do I need to trade?
Thinking about costs should start before you reach the trading screen. Why do you need to trade – is it part of a strategy or a reaction to events? It’s easy to get carried away when markets are moving, to react in haste in times of stress, but this is a surefire way to pay extra.
The Brexit vote was tough on UK equity. On the day of the result, FTSE 250 ETF spreads tripled as the index dropped 7 per cent.
But spreads returned to normal within a few days for those investors who could sit back and wait – and prices recovered in a few weeks.
Choosing your time
We all need to trade sometimes. Even Warren Buffett, whose favourite holding period is for-ever, sells on occasion. But timing can make a difference. Spreads tend to be higher at market open and close when prices are moving rapidly. Beware of trading assets out of market hours too. US equity ETF spreads are often higher in the morning than once US markets open.
Pick your product
Not all ETFs are created equal, so a little bit of research can pay off. Even when ETFs hold the same stocks, some can be have tighter spreads than others. As a general rule, larger, more frequently traded ETFs are most liquid.
There are some cases where it can make sense to choose an ETF with a higher annual charge. Brazil is one of the top trades from 2016, so let’s compare two competing products. Amundi ETF MSCI Brazil has the lowest ongoing charge at 0.55 per cent, but its average spread is 0.65 per cent. HSBC MSCI Brazil Ucits ETF charges slightly more at 0.60 per cent but has much lower spread of 0.23 per cent. If you expect to hold for less than eight years, you are better off with HSBC.
Trade the right way
ETFs are “exchange” traded funds, so it might seem strange that the majority of trading is
not actually done on a stock exchange. Across Europe most ETF trades are executed over the counter, with specialist ETF market-makers.
This is not an issue for small deals – you can get a competitive price through normal dealing services using limit orders. But for larger volumes, more planning is required. If you are trading in bulk, it can be worth setting up arrangements with market-makers who can negotiate trades and access liquidity through institutions. This can save serious money on big trades.
This can take time, so plan ahead. Most ETF issuers have a capital markets team who can advise on what you need and whom to speak with to ensure you get the best prices.