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Figure 2 Figure 3 463 134 ETF Spreads 55 14 $0.01-$0.10 $0.11-$0.20 $0.21-$0.50 $0.51+ Average Spreads Source: NYSE Arcavision. Data for January 1, 2008 through March 31, 2008. 500 450 400 350 300 250 200 150 100 50 0 that’s not really what investors paid. A spot check on April 18 showed the bid/ask spread at $0.80; still high, but well below the artificial $10.99 figure. Number of ETFs 74 208 175 ETF Spread Percentage - Q1 2008 85 42 Source: NYSE Arcavision. Data for January 1, 2008 through March 31, 2008. 29 15 8 5 7 0.0% 0.1% 0.2% 0.3% 0.4% 0.5% 0.6% 0.7% 0.8% 0.9% 1% or Spread % more Figure 4 ETFs With Spreads Less Than 0.1% - Q1 2008 18 Number of ETFs The Spread On Spreads The good news is that the vast majority of ETF spreads are very tight. As Figure 2 shows, 463 of 666 funds had spreads of less than $0.10/share, and 597 funds had spreads of less than $0.20/share. It’s not shown on the chart, but 231 funds had average spreads of $0.05/share or less. The median ETF had a spread of $0.07/share, and the mean spread (ignoring obvious outliers) was $0.11/share. Percentage Basis Another way to look at spreads is as a percentage of the value of the ETF itself. Obviously, if an ETF trading for $10/share has a spread of $0.10, that represents 1 percent of the value of the ETF. If an ETF trading for $100/share has the same spread, that $0.10/ share represents just 0.1 percent of price … a big difference. Here again, the data look pretty good: On a percentage basis, more than half of all ETFs had spreads of less than 0.2 percent of the portfolio value. The vast majority (615 of the 666) had spreads of 0.5 percent or less, and just 18 ETFs had spreads of more than 1 percent. Still, that means that for 51 funds, the average spread was more than 0.5 percent—a significant expense for shareholders that far outweighs any savings on the expense ratio front. Seventy-four ETFs make the honors list by this measure, posting average spreads of less than 0.10 percent for the time period studied. They included three CurrencyShares fixed-income ETFs from Rydex, five HOLDRS, nine ProShares ETFs (two leveraged funds and seven inverse-leveraged funds) and all nine of the Select Sector SPDR ETFs, among others. Large funds also did well: all 10 of the top 10 ETFs by total assets made the list. BGI had the largest number of ETFs on the list (36), including a large number of individual country funds. Larger Funds, Tighter Spreads One question people ask is whether less-established ETFs have larger spreads. To analyze this, I broke down available ETFs by net assets under management. The results are unequivocal. The very largest ETFs—those with assets of more than $10 billion—all had spreads of 0.05 percent or less. As asset size falls, the percentage of ETFs meeting this tightest category Fund Company # of ETFs BGI 36 SSgA 17 ProShares 9 HOLDRS 5 Rydex (CurrencyShares) 3 PowerShares 1 Van Eck 1 Vanguard 1 Victoria Bay 1 Source: NYSE Arcavision. Data for January 1, 2008 through March 31, 2008. falls in lockstep: 56 percent for funds between $1 billion and $10 billion; 13 percent for funds between $500 million and $999 million; 4 percent for funds between $100 million and $499 million; and zero for funds smaller than that. In fact, as you scroll across the grid in Figure 5, you see that there is a direct relationship between net assets and average spread percentage: As assets shrink, spreads widen. Note, for instance, that zero funds with assets under $100 million had spreads of less than 0.1 percent. More Trading, Lower Spreads Likewise, there is a direct correlation between the amount of trading in the fund and the average spread. Figure 6 compares the average spread for ETFs with differing levels of average daily trading volume. Eighty percent of all funds with greater than $10 billion in daily trading volume land in the lowest average spread decile. That shrinks to just 34 percent for funds with between $1 billion and $9.9 billion in trading; 2 percent for funds with between $100 million and $999 million; and negligible amounts for funds with less trading volume. The reverse is true as well: Funds with lower trading volume have higher average spreads. Liquidity Of The Underlying? The old consensus was that the liquidity of the underlying stocks determined the tightness of the spreads. But research shows that it is the liquidity of the ETF, and not the 32 July/August 2008
liquidity of the underlying components that really matters. S&P 500 Example Consider, for instance, the S&P 500 SPDR (SPY) and the RevenueShares Large-Cap ETF (RWL). Both funds hold the exact same stocks—all 500 components of the S&P 500. The only difference is that SPY weights those components by market cap, while RWL weights them by revenues. That shouldn’t impact the liquidity of the underlying, as all 500 stocks in the S&P 500 are deeply liquid. When you look at the spreads data, however, there’s no comparison. For the time period studied, SPY had spreads of less than 0.01 percent, while RWL’s spread averaged 0.9 percent—90 times wider. SPY, of course, is the largest ETF in the world, with over $70 billion in assets; RWL is a newly launched fund, with little in the way of assets or trading interest so far. Muni Bond Example Another example comes from the muni bond space. The muni bond market is notoriously illiquid, and different ETF providers take different approaches to handling this illiquidity. Both BGI and SSgA offer broad-market, nationally oriented muni bond funds. The two funds—the iShares S&P National Municipal Bond ETF (MUB) and the SPDR Lehman Municipal Bond ETF (TFI)—hold roughly equivalent portfolios with roughly equivalent returns. But they have very different creation methodologies. In MUB, APs must go out into the market and buy specific bonds in order to create new shares. Even though iShares designs these creation baskets to hold only the most liquid muni bonds, it is still a hurdle that APs must negotiate to create new shares. TFI, by contrast, uses what’s called a “cash creation basket.” In other words, the only thing APs have to do to create new shares is send cash to SSgA. It couldn’t be easier. However, for the time period studied, MUB had much tighter spreads (0.10 percent) compared with TFI (0.30 percent). The reason? MUB is a larger fund with more inherent trading volume. It’s interesting to note that the spreads on TFI have shrunk as the fund has grown. As of early May, TFI had more than $250 million in assets and higher trading activity, and from May 1 through May 15, 2008, the average spread on the fund was down to 0.20 percent. As the fund continues to grow, its spreads will likely continue to narrow. Conclusion Spreads aren’t as simple as ETF proponents make them out to be. Most ETFs have tight spreads, but not all of them do, and spreads represent a real cost to investors. Especially for newer ETFs with low assets under management, investors would do well to pay attention to spreads when they trade, and use limit orders to avoid paying too much above fair value. Spreads should be incorporated into every ETF trading decision, much the way that brokerage commissions are. Their impact will be felt most by short-term traders, but even long-term investors should consider their planned holding period and incorporate spreads into their trading decisions. [This article expands on an article published in the May 2008 issue of the Exchange-Traded Funds Report.] Figure 5 Net Assets Number of ETFs Source: NYSE Arcavision. Data for January 1, 2008 through March 31, 2008. ETF Spread Percentage By Assets Under Management Average Spread Percentage Decile 0.1% 0.2% 0.3% 0.4% 0.5% $10+ billion 10 100% 0% 0% 0% 0% 0% $1-$9.9 billion 90 56% 43% 1% 0% 0% 0% $500-$999 million 53 13% 72% 15% 0% 0% 0% $100-$499 million 146 4% 53% 31% 8% 2% 1% Figure 6 $51-$99 million 75 0% 25% 47% 15% 8% 5% $10 billion 50 80% 20% 0 0 0 0 $1-$9.9 billion 88 38% 63% 3% 0 0 0 $100 - $999 million 194 2% 53% 31% 9% 4% 2% $10 - $99 million 236 0% 16% 41% 18% 9% 14% 0.5% >0.5% www.journalofindexes.com July/August 2008 33
Page 1 and 2: How Neuroeconomics Can Make You A B
Page 3 and 4: Contributors David Blitzer Matt Hou
Page 5 and 6: David Smith Publisher dsmith@fa-mag
Page 7 and 8: From the world’s leading ADR expe
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Page 11 and 12: • It became a common belief, base
Page 13 and 14: targets; instead, these neural conn
Page 15 and 16: Zweig: Absolutely, it is a lot of w
Page 17 and 18: The naked eye sees ten good investm
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Page 41 and 42: The ABCs Of ETFs Alpha, Beta and Co
Page 43 and 44: Figure 3 Source: ETFGuide.com Avera
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