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Investment Advisers Have Come Around To ETFs

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  • edited February 2014
    The biggest problem with ETFs for an advisor is the bid-asked spread.

    Let's say an advisor wants to invest $10 million in an ETF spread across his clients. Unless the ETF is highly liquid (like SPY) the trading cost from the bid-asked spread could easily be thousands of dollars. And aside from the bid-asked spread, there is also market impact cost- the ETF will start moving up before he can finish buying.

    With a no-load mutual fund, the trading cost is zero.
  • Reply to @MOZART325: Several problematic assumptions here.

    Very few retail advisors deploy $10M at a time into the same fund. Institutional funds already use indexed ETFs for large in and out flows without suffering from these spreads. Some are done in external platforms than open markets so buyers and sellers are matched without much net in or out flow into the ETFs.

    The effect of the bid ask spread in the type of ETFs used for retail investors is negligible unless one were actively trading in it for the short term, not applicable to retail investor. If it was, the daily variation in mutual fund NAVs would be equally destructive depending on what happened the day you bought it. Given the ER advantages of most ETFs, such problems would be in the noise over the long term.

    It is not the liquidity of the ETF that matters but the liquidity of the underlying asset.

    Large net movements in or out of mutual funds also have an effect on fund performance just not so visible. Mutual funds do the same approach of matching buyers and sellers to reduce day to day net effect on cash positions. This is the only advantage of a very large fund.

    Advisors who didn't benefit from fund commissions or kickbacks have long since moved to ETFs for indexed assets while using active mutual funds for non-index strategies. The statistic is more likely a function of decreasing total AUM under advisors who benefitted from funds they pushed than a change of heart or enlightenment amongst them.
  • cman-

    Schwab recently added some commission-free sector funds. I bought 500 shares of RYH a few weeks ago (around $50K) and the bid-asked spread was consistently around 10 cents or about 0.1%. There was also a considerable amount of tracking error between the ETF and indicative value and even the bid price of RYH sometimes traded well above indicative value.

    I was not comfortable using a market order for 500 shares, so I wound up doing five separate trades of 100 shares using limit orders and tried to buy only when RYH traded at or below indicative value. Quite time consuming!

    With an open-end mutual fund, I could easily buy $50K of any mutual fund with one click of the mouse, with no tracking error issues and no bid-asked spread. Most advisors need to buy much more than $50K of an ETF and would pay higher costs due to market impact. I would imagine that many advisors assign the trading function to an assistant who buys using market orders.

    Large net movements in or out of mutual funds can affect fund performance, but the cost or benefit is shared by all shareholders not just by the buyer or seller. With an ETF, the buyer or seller pays for the entire trading cost. Some of the new ETF strategies involve frequent rebalancing, so the trading cost can be quite significant over time.
  • Reply to @MOZART325:
    For long term holding, the premium at purchase is in the noise even if as high as .1%. You normally buy ETFs that have cheaper ER than the corresponding mutual fund. The effect of the difference in ER year after year for the same index makes any onetime premium look moot in comparison.

    The fact that net flows don't affect the ETFs as much as they do in ETFs is a big selling point of ETFs. Again, you are worrying about the one time premium while there is an opaque effect YOUR holdings will have in a mutual fund as money flows in and out of a mutual fund and everyone gets affected. You just don't see it explicitly.

    Seems like a case of penny wise and pound foolish to me.
  • Reply to @MOZART325:
    Schwab recently added some commission-free sector funds. I bought 500 shares of RYH a few weeks ago (around $50K) and the bid-asked spread was consistently around 10 cents or about 0.1%.
    So you bought a commission-free ETF and had a 0.1% spread differential. However, as others pointed out, paying a lot lower ER with the ETF than you would with a similar mutual fund (ER of RYH = 0.50%, similar mutual fund > 0.8%). So even with your 0.1% spread you're still better off by at least 0.2% expense-wise.

    And as far as tracking error, over 5 years, the difference between price and NAV has been 0.09%.

    Sure there are some spread risks in ETF's but you can minimize those, as you have, with using limit orders. And over time those minuscule spreads you may pay will be far less than the paying ER or even the spreads that the mutual fund manager has to pay by buying and selling stocks themselves for the fund.
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