By Matt Schreiber – WBI President and Chief Investment Strategist
As President and Chief Investment Strategist of WBI, I talk to probably thousands of advisors during the course of a business year. One of the biggest misnomers I hear about ETFs is how to measure the liquidity. Is it tradable? Is it not tradable? Everybody thinks volume is the number you need to be looking at. We invited Douglas Yones, Head of Exchange-Traded Products at the New York Stock Exchange, to our 50th podcast episode of Bull|Bear Radio to bust this myth.
Q: Unless you understand liquidity, you may not be jumping into ETFs. I think a lot of advisors and investors have been taught that ETFs are like a stock. They trade like a stock, and therefore, volume is what people look at. Either it’s tradable or it’s not tradable – but that’s not the case, is it?
Doug: No, it couldn’t be more wrong. They’re using volume as a measure for something that it shouldn’t be used for at all.
Q: Wait a second. Did you just say volume should not be used at all?
Doug: At all.
Q: In determining liquidity in an ETF?
Doug: I think back to my mathematics engineering side. When you go back to mathematics, we would have X plus Y equals Z.
And then take your equation from there. If Z is the liquidity of an ETF, the volume of that ETF is not part of the equation. It’s just not in there. What is in there is the underlying components of the ETF. So every day, WBI and every other ETF in the world publishes something called “the basket”. And that is the way an investor creates shares or redeems shares. The input is the basket.
When we look at the basket, that basket could be cash. That basket could be 50 stocks. It could be the S&P 500 stocks. It could be 1500. It’s whatever that basket is. That’s what the market maker has to go buy or sell and then deliver to the fund in order to get the ETF shares.
Doug: Nowhere in there did I say that the market maker had to go and buy the ETF and deliver that. They’re not delivering the ETF. They’re delivering the basket, and they’re trading the basket, and they’re using the basket to hedge, and it’s all about the basket. But look, let’s be realistic, people don’t look at the basket.
Q: They’re looking at the volume.
Doug: Exactly. They say, “Well, I look at average daily volume, and it doesn’t trade that often.” It’s irrelevant in the world of ETFs because, again, it’s the basket. It’s the equivalent when you look at an S&P 500 ETF. Are you really going to look at the volume of that?
Q: Right. I mean, you’re talking about the biggest 500 companies in America that trade all day long.
Doug: Yes. And when you break it down, almost every ETF out there, it’s the same thing.
Q: So you could double the fund’s size in an ETF, in a day, and theoretically, you should get tight spreads?
Doug: You should have no problem with that trade.
Q: If the underlying basket is actually liquid.
Doug: That’s right. Now let’s say you have a $10 million ETF, and an institution comes along and wants to put another $10 million into it. Guess what happens? That new investor, that institution, has to go and buy $10 million worth of the basket. Talking about that basket.
Q: It’s all about the basket.
Doug: They buy $10 million worth of the basket, then hand the basket to the ETF and they get their shares back. Your investor? No impact.
Q: That’s right.
Doug: They didn’t pay the spreads. They didn’t pay the commissions. If it was a sell, and there was a taxable event, it didn’t happen. It’s fair and easy, and ETFs are also more tax efficient. This is why we love ETFs.
For more on this topic, listen to Bull | Bear Radio #50: ETF Liquidity Explained: Why Volume Doesn’t Matter
Past performance does not guarantee future results. The views presented are those of Matt Schreiber and Don Schreiber, Jr. and should not be construed as investment advice. Matt Schreiber, Don Schreiber, or clients of WBI may own stock/sectors discussed in this article. All economic and performance information is historical and not indicative of future results. This is not an offer to buy or sell any security.No security or strategy, including those referred to directly or indirectly in this document, is suitable for all accounts or profitable all of the time and there is always the possibility of loss. Moreover, you should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice from WBI or from any other investment professional. To the extent that you have any questions regarding the applicability of any specific issue discussed to your individual situation,please consult with WBI or the professional advisor of your choosing. This information is compiled from sources believed to be reliable, accuracy cannot be guaranteed. Information pertaining to WBI’s advisory operations, services,and fees is set forth in WBI’s disclosure statement in Part 2A of Form ADV, a copy of which is available upon request. An investment in WBI ETFs are subject to risk including possible loss of principal. Investments in fixed income involve risk and may be adversely impacted when interest rates fall because the fund may be exposed directly or indirectly to lower yielding bonds. Investors should consider the investment objectives, risks, charges, and expenses carefully before investing. For prospectus and summary prospectus visit wbishares.com or call 1-800-772-5810. Read the prospectus carefully before investing. Foreside Funds Services distributor.
An investment in WBI ETFs are subject to risk including possible loss of principal. Investments in fixed income involve risk and may be adversely impacted when interest rates fall because the fund may be exposed directly or indirectly to lower yielding bonds.
Investors should consider the investment objectives, risks, charges, and expenses carefully before investing. For prospectus and summary prospectus visit wbishares.com or call 1-800-772-5810. Read the prospectus carefully before investing. Foreside Funds Services distributor.
You are not permitted to publish, transmit, or otherwise reproduce this information, in whole or in part, in any format to any third party without the express written consent of WBI Investments, Inc.