We fear what we don’t understand, and it seems like exchange traded funds (ETFs) might be one of the most glaring examples of this adage these days.
The “flash crash” brought to light some issues with ETFs and hundreds of other securities. Street One Financial’s Paul Weisbruch in a column for RIA Biz says that much of the criticism of ETFs in the past had been easily dismissed because those making the criticisms more often than not didn’t fully understand them. But thanks to the events of May 6, some of those criticisms should be addressed in greater detail. Here are some of Weisbruch’s thoughts:
- Manipulation: ETFs might have funny closing prices some days, but “funny” closing prices can occur on any given day in individual stocks, too. These often are the result of sloppily executed market on close orders (MOCs) generated from mutual funds that need to buy or sell certain securities into the closing bell, and often the next day in the marketplace, these securities regress back to their fair price. [New Fee and Disclosure Proposals for ETFs.]
- Gaming by the big guys skews security prices: It is true that an ETF can trade at a discount or premium to NAV, but simple research into the daily facts that are supplied on the ETF issuers’ websites will show that these discounts and premiums are largely statistically insignificant.
- Smart trading desks would not sell into panic: ETF-centric trading desks evaluate ETFs on a “basket” or “index” level, and just because the ETF may have appeared to have traded 10 cents on May 6th if the underlying constituents were trading at prices that would imply the ETF should be valued at say $39, a smart trading desk would not be selling into the panicked activity.
- Too many basis points: The commission on ETF trades is something to factor in to your overall decision. But the intraday trading flexibility can more than make up for this, in addition to the fact that many brokerages are reducing and even eliminating commissions on some ETFs. [ETFs are More Than a Mutual Fund Alternative.]
For more stories about ETFs, visit our ETF 101 cateogry.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.