ETF Expert

When the investing public has little interest in a particular exchange-traded vehicle, the company sponsoring the ETF may be forced to close the fund. And while you’re not at risk of losing an entire investment, you may not get an adequate liquidation price for having participated.

The essential issue is thinly traded volume; that is, the difference between the asking price and the bid price may be so wide, it becomes prohibitive to buy or sell.

For example, the S&P 500 SPDR Trust (SPY) trades so many shares at a high enough dollar value, the difference between the bid-ask price is negligible at 0.01%. For the iShares Global Consumer Staples Fund (KXI), maybe that spread is closer to 0.20%. Round-trip, that may cost you 0.40%, or 40 basis points.

Yet, there are dozens upon dozens of funds like E-TRACS Short Platinum ETN (PTD).  Ron Rowland at Seeking Alpha noted that the 11/19/09 bid-ask spread was 1.2%, or… 2.4% in expense for the privilege of a round-trip purchase.

I positively love Ron Rowland’s “Deathwatch” Series. It reminds us that… in spite of 97 new exchange-traded investment launches so far in 2009… there are at least that many ETFs that need to go away.

Rowland’s criteria are easy to wrap one’s head around. Specifically, if an ETF/ETN has been around for more than 6 months, and if it trades on average less than $100,000, the investment is an expensive menace. (In fact, if you think 2.4% on an ETF is tolerable… try getting out with a 10% spread before the markets hit a volatile collapse and nobody is bidding!)

Ironically, there are many terrific ideas that have yet to catch on. In theory, State Street’s developed international sector funds should have spectacular interest. In practice, however, the bid/ask risk of entering SPDR International Consumer Staples (IPS) or SPDR International Utilities (IPU) may be too great.

The same holds true for several emerging market sector funds that entered the scene 5 1/2 months ago: Emerging Global Shares Energy (EEO) and Emerging Global Shares Metals & Mining (EMT). The former trades $150,000 worth on average whereas the latter trades about $250,000 on average. While this doesn’t meet Rowland’s “Deathwatch” of $100,000 or less, it is woefully low volume for getting a desirable price execution.

Emerging Global’s Emerging Market Index Composite Fund (EEG) is a bit safer at an average dollar trading volume of $300,000. It combines ten economic sectors into an aggregated fund for broader exposure.

Yet, why would an investor risk investing in EEG with volume at $300,000 when the Vanguard Emerging Market Fund (VWO) has dollar volume of $350,000,000? VWO costs less to buy, costs less to sell and costs less to hold in an annual expense ratio. As for performance since EEG launched on 7/22/09, the returns are nearly indistinguishable.

If you’d like to learn more about ETF investing… then tune into “In the Money With Gary Gordon.” You can listen to the show “LIVE”, via podcast or on your iPod.

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