Page 45 - DIY Investor Magazine | Issue 32

Another goal may be to figure out if you’re going to be able
to unwind your position when you want. While measuring bid/ ask spread can be used effectively with ETFs, the notion that a fund’s Assets Under Management (AUM) or Average Daily Volume (ADV) has anything to do with your trade getting filled is just plain wrong.
As I mentioned earlier, ETF shares represent ownership in a basket of securities. This is important because when you place an ETF buy order, you are essentially investing in the underlying shares held by that ETF.
Say I just launched a new FANGMAN ETF [1] and on day one it lists with 100,000 shares at a $15 NAV giving it AUM of $1.5 million.
Because I have a great marketing team, everyone wants shares of this fund as soon as it is listed.
‘INVESTORS CONCERNED ABOUT LIQUIDITY SHOULD STOP WORRYING SO MUCH ABOUT ETF SIZE AND INSTEAD FOCUS ON THE UNDERLYING HOLDINGS.’
Are they all fighting over 100,000 shares of a $1.5 million fund, driving up share prices and creating liquidity issues? Of course not.
Those FANGMAN stocks represent a combined market cap of about $7 trillion so even if on day one I have $1 billion of inflows, it doesn’t matter because market participants, using the creation and redemption mechanism, are going to deliver $1 billion of equities from a pool of $7 trillion!
This example might seem extreme but the principle is the same even if you’re talking about relatively small ETFs. The AUM and trading volume of an ETF should be irrelevant when it comes to evaluating the fund’s strategy.
If you want to gauge a fund’s ability to absorb your trade, look at the current holdings and do some quick math to figure out if the allocation of your investment is going to create liquidity issues for any of the underlying securities.
Over the years, I have spoken at various conferences and explained this to rooms full of brokers and retail investors alike. During my presentation I always see heads nodding in agreement and a few indications of enlightenment.
Invariably, sometime later in the conference I will be talking to some of these same folks and ask them their thoughts on a new or lower AUM fund and the immediate reaction is, ‘too small, not enough volume.’
Investors concerned about liquidity should stop worrying so much about ETF size and instead focus on the underlying holdings.
When you invest in ETFs, your capital is at risk.
[1] FANGMAN represents the following companies: Meta (Facebook), Apple, Nvidia, Google, Microsoft, Amazon and Netflix
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DIY Investor Magazine · Feb 2022