Ask a client what they want to invest in, and the answer will almost certainly include ETFs. This market became a standard way to allocate assets a long time ago and is only growing each year. New funds are coming every week, and in the first half of this year the U.S. market has already launched about 700 new funds, nearly as many as in the whole of last year.
It should be good news for advisors as they have an opportunity to find the right tools for every one of their customers, no matter if they want to invest in crypto or in a niche emerging market. Getting a client into a fund has never been easier, but after that the hardest part is yet to come.
This is so because an ETF is only as liquid as the assets it holds. While the fund may look like a share on the screen and traded hundreds of times an hour, underneath it may be holding bonds that trade a few times a day. It would not be a problem if clients place small orders, but the large ones would eventually move the whole underlying market. When advising a client on which ETF to choose, advisors should consider the client's capital and the possible impact on liquidity of the underlying assets.
Several years ago, access to sophisticated products was the selling point, and if an advisor could put a client into a specific fund that their bank could not reach, that explained why customers paid for such services. But today this advantage has disappeared, and retail brokers now offer access to almost every asset, often at a much lower cost than specialized companies charge.
It means that value for clients should come from somewhere else. From my perspective, it should be the part clients cannot see. Today, many of them are looking for some specific and even exotic ETFs as they have grown bored with investing in traditional companies and indices.
These newer funds are built on complicated assets and rules, but the problem is that the wrapper hides all of it. Clients often don't know that when they buy or sell an asset, something has to happen in the market underneath, and that market may not be ready for the size of their order.
To understand why this is even a problem, take a fund that holds emerging-market debt, for example. Investors may trade the fund all day long, far more often than they could ever trade those bonds directly, which makes it look liquid. But eventually someone has to buy or sell the actual bonds, because without moving them a significant gap would appear between the price of a basic asset and an ETF. Eventually, it could lead to losses for clients.
This challenge is widespread because more than a quarter of listed ETFs trade fewer than 5,000 shares a day. However, it is important not only for some exotic sophisticated funds, but even for the most liquid assets if the situation is critical. In March 2020, when the cash bond market froze during the COVID pandemic, ETFs holding 20-year US Treasuries, the most liquid tool possible, were traded with a 5% discount. If this can happen to such popular assets, it is even more true for thousands of other funds on the market.
All of the above explains why advisors should know what products they offer even if they don't provide trades themselves. They should know literally everything about the platform and underlying asset market to handle execution, especially when it comes to clients with large orders. There are several things that may help advisors to learn this information.
It is worth starting with looking at whether the firm behind the trades can deal with different asset classes and several exchanges. Sometimes it may be better to find a specialized platform for clients because the one that is built for large popular ETFs may not handle small exotic trades well.
After that, look at how they reach the market and find a company that works with more than a single partner to make trades. Depending on a single company may lead to losses, so the firms that can put a few market makers in competition often get better results.
Finally, see exactly how the firm grows, because it is not so difficult to place hundreds of new funds in contrast to making sure they are traded properly. You can consider a longer product list as an advantage only if the trades are executed properly.
The hard part here is that clients only notice execution when it goes wrong and they have to sell assets at a discount. For this reason, it may be overlooked, but in critical situations clients will remember on whose advice they placed a specific order.
That's why advisors should work closely with funds and examine all the details. It may not be the most exciting work, but it will certainly pay off over a few years as they build a reputation for never letting their clients down.
Arthur Azizov is CEO and founder at B2BROKER Group and B2BINPAY.
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