In switching over to ETFs, financial advisors need to be aware of some differences in making orders. We’ll give you the information you need for seamless and efficient trading.
When trading in mutual funds, an advisor may pick out what to purchase and upload the trade to all their accounts with no fuss since the price is the same at the end of the day.
However, the price of an ETF, like stocks, changes throughout the day, with a different market ask price. The use of block trades when it comes to buying and selling ETFs would be more prudent in executing orders.
Block trading involves pushing through sizeable orders all in one shot and gives each client the same price. Advisors have several options when it comes to block trading.
Do It Yourself
In the trading platform for your custodian, trade the total shares in a block and not your individual client accounts. Know the ETF you are trading – volume, bid/ask spread – if you place too big of an order in too small a fund, you could wind up moving a fund’s price more than you had intended.
Large buy/sell orders can be made piece by piece so as not to affect the ETF price. For example if you are trying to buy 100,000 shares of an ETF, put in several trades of 10,000 or 20,000 shares. After each buy or sell, observe and analyze the market’s reaction to the orders placed.
Trading this way, in conjunction with limit orders, will give you better control over when and where the trades are executed at a price specified by you. This trading strategy is especially useful if an ETF is trading at high volumes with lots of liquidity.
Call Your Custodian
If the ETF you are trading has low volume or there is concern about affecting the volume and price of the ETF, then contact your custodian. There are several ways the ETF trading desk can help you place your trade – remember to use a block trade and the total amount of shares you want to trade.
One option is to get a risk bid/offer. The trading desk will take your order and call the authorized participants they work with to get a quote on the whole trade. The trader gets the quote and you have the option to accept or decline the trade – but you have to act fast, the market could move while you have the participant on hold. Talk with your trading desk prior to making the call for the offer so you have an idea of what you might accept when the quote comes back to you.
Other options include the ETF trading desk taking the whole trade and working it on their side. They have more up-to-the-minute information and can see what’s going on in the markets. Give them a limit price for them to work with and a time frame for working the trade. You can stay on the line or agree to check back with each other in a specified time or if the market begins to move away from your limit price.
Another option is to have the trading desk place a Volume Weighted Average Price (VWAP) order. The VWAP is calculated by adding the dollars traded for every transaction in that ETF (price x number of shares traded) and dividing the total shares traded. You can give a beginning cut-off time and an ending cut-off time, and is calculated by volume weighting all transactions during this period. Your trader should be able to help you through this process in setting up the trade.
Other trading options may be available from your trading desk, so call and ask what they can do for you.
Alternate Liquidity Providers
Imagine a world where you can have any exchange traded fund (ETF) you want. A world in which trading volume, assets under management and a wide bid/ask spread no longer are feared. Thanks to ETF providers and a growing industry of what are known as “alternate liquidity providers,” it can happen.
When you’re dealing in volume, buying and selling an ETF isn’t just a matter of finding a fund with all the qualities you desire – billions in assets, heavy trading volume, strong performance, low cost – and clicking “buy.” Attributes such as trading volume and assets used to be major considerations for investors because it tended to be that low activity in a fund led to wide spreads, bigger costs and, in a worst-case scenario, no one to buy the fund you’re holding when you’re in the market to sell it.
The benefits of using an alternate liquidity provider include:
- Improved volume and trading conditions.
- Diminished investment costs as liquidity increases.
- Better pricing formation.
- Diminished risk of wide price volatility.
For all block trading, the average price of all the trades at the various points would be allocated shares to each client’s account. In accordance with compliance rules, all of the accounts would hold the average price of set shares from the day’s trade so as to show that there is no front running and no favoritism to any one client.