The ever-expanding number of exchange-traded funds attract more financial advisors each year––54 percent reported using them in 2011 versus 45 percent in 2010, according to Cerulli Associates. [Data for 2012 won’t be available until later this year.]
Despite their growing popularity among advisors and the general investing public, a lot still is not understood about ETFs, says Robert Gregov, founder and president of Roche Financial Partners, an RIA based in Princeton, N.J.
“Even now when I present a model [to clients] and say that I use exchange-traded funds to execute it, I get some confused looks,” he says. “People still are learning about ETFs and that is true among RIAs, too.”
For example, he notes, even though expense ratios for ETFs have dropped dramatically, advisors and clients still need to monitor brokerage costs and understand market pricing.
Gregov recently shared observations with two other industry principals during a webinar entitled “How You Can Benefit from the Growing Use of ETFs,” sponsored by Interactive Data, a financial data and market services company. Portfolio allocation, liquidity and price were among the topics covered during the one-hour session.
“Advisors do look at volume when choosing an ETF,” said Ugo Egbunike, a senior ETF specialist for Index Universe, an ETF news and research provider. “More important, though, is the bid/ask spread of the ETF versus the underlying securities.” He mentioned an article last year in The Wall St. Journal that said investors should consider the total entry and exit cost for holding an ETF for a full year.
Gregov said his shop compares the bid/ask spread of both the fund's holdings and the underlying stocks. “We also like to see some volume in a fund,” he noted. “You could say the bid/ask is an indication of the underlying securities' liquidity. But we like to see them in conjunction with each other.”
“Sometimes a lot of the liquidity can't be seen,” said Eric Pollackov, managing director of ETF Capital Markets for Charles Schwab. There are different markets in which to execute an order, and some may be more liquid than others. Pollakov said advisors who are unsure of where to best execute an order can talk to a professional at one of Schwab's two advisor-dedicated desks.
Pricing can get complicated since ETFs may trade throughout the day at a premium or discount to their net asset value. Gregov said he’ll take this into account when he moves into and out of a fund––particularly less liquid funds in areas such as small-cap emerging market equities. “I want to be sure when buying into the fund that we ask the [fund company] why the market price is deviating from the NAV.” he explained. “It could be that the ETF always trades at premium to NAV.”
But if the trading price is volatile and always rising and falling in relation to the NAV, he said he’ll consider buying another product.