Time trades for international ETFs. Generally, it’s better to trade international ETFs when the international markets that correspond to the ETF are open. The prices of international ETFs that trade in the U.S. tend to track the value of the underlying securities more closely, and have narrower bid-ask spreads, when trading hours between markets overlap.
Diversified international ETFs that span the globe can get a little tricky here. Chad Carlson, a wealth manager at Balasa Dinverno Foltz in Chicago, recalls when his firm recently sold a large block of an international ETF based on the MSCI EAFE index. “One of our tactics was to trade when as many markets were open as possible because we knew they all couldn’t be open at the same time,” he says. “And we needed to be sure that places like Japan were not on weekend or holiday at the time of trade. Those factors would cause market makers to price in a little more risk.”
Look at liquidity. It’s a common misconception that an ETF has to have a lot of trading volume to be liquid, according to Ed Rosenberg, head of ETF Capital Markets and Analytics at ETF sponsor FlexShares. He points out that on-screen trading volume is a faulty indicator of liquidity because it shows only what has traded on the secondary market, not necessarily what the price of a future trade could be. “A lot of advisors are setting volume thresholds when they really don’t need to,” he says. “That really limits the ETFs they can invest in.”
A much more important proxy for ETF liquidity, he says, is its underlying securities. If those trade actively, it’s easy for authorized participants to create and redeem shares, regardless of the ETF’s trading volume.
Commodity and currency exchange-traded products are firm territory from a liquidity standpoint even if they don’t have substantial trading volume, since the underlying futures and other non-equity investments aren’t liquidity-constrained. Ditto for most ETFs that focus mainly on large and mega-cap stocks. On the other hand, an ETF that tracks a couple of dozen small-cap stocks in a specialized sector, or an international offering specializing in obscure markets, could be a harder to handle.
Get a helping hand if you need it. ETF sponsors such as Vanguard or State Street, as well as custodians such as Schwab or TD Ameritrade, can help advisors get the best prices possible, particularly when it comes to large trades. Rosenberg says advisors often consult a block trading desk when their trade exceeds more than 10% to 20% of the ETF’s daily trading volume, or more than 10,000 shares.
Could An ETF Flash Crash Happen Again?
With ETFs now accounting for about 30% of daily equity trading volume, investors depend on the complex process of creating and redeeming ETF shares to work with unerring precision. With few exceptions, it does.
But there have been two notable instances in less than a decade when things broke down in a big way. The first was during the “flash crash” of May 2010, when the Dow plunged 9% in the span of a few minutes. The sudden freefall left many ETF market makers unable to value holdings accurately, causing pricing disruptions among ETFs. More recently, market prices briefly decoupled from net asset values on August 24, 2015.
To help protect investors from another ETF glitch, the New York Stock Exchange, Nasdaq Stock Market and Bats Global Markets stopped accepting stop-loss orders in late 2015 and early 2016 (although brokerage firms can still execute a trade triggered by a stop-loss, since it goes to the exchanges as a market order). ETF sponsors such as SSGA, BlackRock, Charles Schwab and Vanguard have also been working to minimize pricing disruptions, and in August of this year SSGA organized a panel discussion on last year’s massive glitch and how the industry responded. And the SEC recently announced approval of an NYSE proposal to eliminate Rule 48. The rule, which was designed to open markets quickly during extreme volatility, has been cited for having the opposite effect.
There is some evidence that steps toward reform are working. In one encouraging sign, Bats Global Markets reported just 68 trading halts on June 24, the day that Brexit results were made public. That’s a far cry from the 1,278 trading halts reported on August 24.