Even though USA assets under management for Exchange Traded Products (ETPs) climbed 27% in 2012 to reach $1.3 trillion the mood at the recent IndexUniverse’s Inside ETFs Conference seemed subdued. Perhaps it was because over 90 funds closed in 2012, there is brutal competition for assets, and the big players are squeezing basis points (.01%) out of cost structures.
On the bright side ETPs are starting to tap into 401 (k) accounts ($3 trillion in assets), actively managed products are starting to become available, and brokerage giant Schwab endorsed a broad set of SPDR, Guggenheim, PowerShares, ETF Securities, and United States Commodity ETFs in addition to their branded funds with their Schwab ETF OneSource™ program.
During the Monday morning session of the conference six things were emphasized:
There’s more to ETF cost than the annual fee
- If you aren’t planning to just buy and hold your ETF investment then commissions and the typical spread between bid and ask prices can be more significant than the annual fee. For example if an ETF trading at $25 typically has a 10 cent spread, each round trip cost of buying and selling totals 0.4% —which could easily be more than the annual fee.
- Typically the larger the fund, the smaller the bid/ask spread and the greater the liquidity—its ability to absorb larger orders without affecting the price
- Funds that have assets under $10 million are probably unprofitable. If the fund is new that’s not a problem, but if the fund isn’t growing there is a risk of closure. Funds don’t nosedive when their sponsors announce closure— typically they are still tracking their respective index, but you should exit before the final closure date so that you don’t get stuck with closing costs.
- Unless a fund has assets in the billions a surprisingly small market order (e.g., over a 100 shares) can net out at a crummy average price. For orders in the 100 to 1000 share range you will probably get good execution using a limit order at the current bid or ask price depending on whether you are selling or buying. If you have trouble keeping the bid and ask straight just consider which is worse for you—that’s the pertinent price.
- If you are buying or selling thousands of shares in a relatively illiquid ETF you should consider reaching out to market intermediaries to transact your trade. Attempting to piece out the trade yourself will be time consuming and likely expensive. The market is very good at sniffing out trades like this.
- The dollar has not been particularly strong in the last five years. If the dollar strengthens your foreign investments will be hurt unless they are hedged for currency. You can hedge this risk directly with currency plays, or you can buy ETFs that have currency hedges built-in.
- All volatility, interest rate, currency, and most commodities ETFs use futures.
- It’s not rocket science. Term structure just refers to the prices of futures as their expiration dates go out further in time. If those prices go up, above the spot price, the term structure is said to be in contango. This is the most common case.
- If the prices go down in time, below the spot price, the term structure is in backwardation. Backwardation tends to be unusual and short lived—it occurs when markets are disrupted and there’s a lot of immediate demand for the underlying.
- Term structure is important because it can be a considerable drag on your investments. Futures that are in contango lose value as they converge on the current spot price—any ETF that buys them will go down in value too.
- Term structure can also be a boost to your investments—you want to be long futures with backwardation and short with contango.
- Even though interest rates will likely stay low for a while, they can’t stay down forever. Inevitably some people will get burned badly—bonds with duration of 10 years will go down 10% with every 1% increase in their effective interest rate.
- Schwab added a large number of fixed income non-Schwab ETFs to their commission free program—including Guggenheim’s Bulletshares® defined maturity corporate and high yield funds that offer durations as low as one year with good yields.