Page 17 - DIY Magazine September 2018

GAUGING ETF LIQUIDITY
There isn’t a single measure of liquidity but the bid-offer spread is the most serviceable proxy; broad, efficient market ETFs tracking the most popular indices will generally have tight spreads. But it’s well worth paying closer attention to the spreads of specialised ETFs such as:
Emerging market ETFs
Smart beta ETFs Sector ETFs Commodity ETFs High yield bond ETFs
Bid-offer spreads fluctuate every day depending on market conditions so it’s a good idea to check in on your chosen ETF’s spread over the course of a few days to assess its size, especially against rival products.
Your online broker or the ETF’s fund provider should both provide buy and sell prices on their websites. If there’s little to choose between ETFs then the most liquid over time will tend to be the ones with the most assets-under-management (AUM), daily trading volume and market makers.
CAN I SELL MY ETF ANYTIME?
Bid-offer spreads can and do widen during market turmoil, particularly in niche markets. This is because market makers are exposed to greater risk when they buy ETFs from sellers and move them on to new buyers. In a falling market, a wider bid-ask spread ensures
the market maker doesn’t take a huge loss if their ETF shares are bought at a lower price by the new buyer.
Market makers will tend to fatten their margins at times like this but an ETF will continue to trade as long as the underlying market remains liquid. There were no serious problems with ETF liquidity during the turbulence of
the dot.com bust or the 2008 financial crisis, but there are more exotic ETFs available now which haven’t been tested under the severest conditions.
It’s impossible to predict how ETF’s tracking a less liquid market like high-yield corporate bonds will perform in
a crisis, so restrict them to a relatively small proportion of your overall asset allocation if you run a portfolio strategy such as Core-Satellite.
THERE ISN’T A SINGLE MEASURE OF LIQUIDITY BUT THE BID-OFFER SPREAD IS THE MOST SERVICEABLE PROXY
Good to know: The London Stock Exchange does limit the maximum spread market markers can charge but the rules can also be temporarily suspended when markets are highly volatile.
Our tip: ETFs that track Asian securities are best traded early in the morning, while you should wait until the late afternoon to trade ETFs weighted towards the US or Latin America. To learn more about ETF stock market trading and trading hours, read our article ‘How does ETF trading work?’
17 DIY Investor Magazine | Sep 2018