It’s a trader’s market for ETFs, but exercise caution

FEB 11, 2009
By  Bloomberg
What’s an adviser to do when his or her clients can’t even look at their 401(k) statements because the statements are too depressing and clients have lost thousands of dollars? Investors who have ridden their portfolios to the bottom can attest to the fact that although the buy-and-hold strategy is not completely dead, it certainly is in intensive care. The truth of the matter is that this strategy alone no longer works under current economic conditions. A better strategy may prove to be a tactical overlay model using exchange traded funds in which 60%-70% is buy-and-hold and the remaining 30%-40% is actively traded using the 200-day moving average. Choosing ETFs is simple, and they certainly demonstrate vast advantages over mutual funds and other investment tools. Their tax advantages are superior. They’re more cost effective and completely transparent. Aside from their ease of use, though, advisers need to consider certain things before diving in. Liquidity. ETFs with a low trading volume or few assets simply won’t be as liquid as the larger ones. Be sure to check these figures before buying, so you don’t get left holding the bag. A standard measure of “good” asset size is around the $100 million mark. Commissions. Because ETFs trade throughout the day like stocks, they are subject to commission charges made by brokerage firms. Each firm is different, but lower commissions can be charged if accounts are set up in certain ways. For example, if clients get statements online, it could lower the commission charge. Or if the account value is at a certain level, the fee could also be lowered. Average pricing. When trading the same ETF for multiple accounts, it’s possible that each account could get a different price if the ETF was traded for each individual account. With major custodians, if you do a block trade for the full number of shares you want to buy or sell, then you can allocate the shares to the individual accounts with the same average price. This ensures that all clients will receive the same purchase or sale price. Large trades can be broken down into smaller parts (for example, if you are buying 100,000 shares, you can place 10 trades of 10,000 shares each). The average price of those trades would be allocated to individual accounts. Limit orders. When placing a trade, you can put the trade in at market and execute it at whatever the going rate is at the time you submit the order. Therefore, in order to ensure that you stay within an acceptable range, you can place a limit order to put a cap on the amount you are willing to pay. If the ETF is thinly traded, placing a large trade could affect the price substantially. Therefore, setting a limit could keep the price from getting unwieldy. When you are block trading, setting limits can also help keep the price within a specific range. Knowing how to use and trade ETFs and incorporate them into a tactical overlay strategy can take your advisory business to a new level that’s in line with current market and investing conditions.

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