The U.S. exchange traded fund industry has accumulated over $2 trillion in assets under management, but the majority of assets remain allocated toward the largest offerings, potentially causing investors and advisors to miss opportunities in smaller or lesser known ETFs.
“The next time you are looking for an ETF solution to solve a client’s needs, do not eliminate what may be the best solution simply because of how little it trades,” Brandon Clark, director of ETF product management at Legg Mason, writes on InvestmentNews. “Talk to the ETF sponsor about liquidity. Most can quickly assess how it matches both your client’s investment goals and liquidity needs. A little time and discussion could make the difference in the success of your client’s investment plan.”
While investors should be wary of risks associated with an investment’s liquidity, financial instruments do not all work the same, which can cause investors to focus on the wrong things, Clark warned.
Instead, Clark believes advisors and investors should keep investment exposure as their main priority.
“Making trade-offs between ‘low-volume’ ETFs that fit your clients’ needs, and ‘high volume’ products that can compromise clients’ needs could be the difference between their success or failure,” Clark said.
Potential investors should also keep in mind that new ETFs with innovative strategies all start out with low assets and trading volumes in the beginning months as more people become aware of the products. ETFs that show huge trading volumes now started off as relatively unknowns when they first came out.
Currently, over 90% of ETFs trade less than 500,000 shares per day and 75% show less than 100,000 shares per day. Nevertheless, these same low volume ETFs may still have millions in assets under management.
“The reality is most clients use ETFs as asset allocation tools, not trading vehicles,” Clark added.