“That is part of the growing pains. As an ETF grows larger, if it owns securities that are illiquid, something will have to give,” Iachini says.
Liquidity concerns in niche markets reached the Securities and Exchange Commission, which released a draft rule in October, Iachini says. He says the draft rule requires ETF providers to disclose their market makers as the SEC believes providers aren’t doing enough to effectively monitor how close each ETF is trading to its net-asset value. The SEC is also concerned market makers won’t want to make markets during times of extreme volatility, which has happened during flash crashes. Although the rule is set to go into effect next year, whether it happens remains to be seen since there is a new presidential administration and changes at the SEC, he says.
For advisors concerned about illiquid ETFs, Iachini’s advice is simple: Stick to the more liquid ETFs, and “if there’s some flash crash move … in a short period of time, the answer is: don’t trade.”