ETFs can present pricing problems

25-Apr-2011

I like this.

By

Mr. Guliyev is specialized in international relations / business, global governance and investments areas. He is committed to be successful.







By Jessica Toonkel

 

When Tom Lydon switched from working solely with mutual funds to using exchange-traded funds in 2000, he quickly realized that it was a whole new ballgame. Previously, Mr. Lydon, a registered investment adviser and president of Global Trends Investments, simply could submit a block trade when he wanted to change the allocation of his model portfolios for his clients. He knew his trades would go through at whatever a fund’s net asset value was at the close of markets that day.

But with ETFs, Mr. Lydon had to put in place back-office processes so his firm could stay on top of the bid-ask spreads of the ETFs, as well as their liquidity, to make sure he got the best prices on his trades.

“With ETFs, there are a lot more decisions that advisers need to make about how they will conduct their trades to make sure they get the best execution,” he said.

As more advisers move from using mutual funds to ETFs, many of them aren’t aware of the intricacies of trading the newer funds, experts said. And while these advisers move to ETFs because they tend to cost much less than mutual funds, they could be leaving money on the table, particularly with less liquid ETFs, if they don’t do everything they can to guarantee the lowest prices, said Dave Nadig, director of research at IndexUniverse.com.
‘BLINDSIDED’

“I think there is an entire generation of very good financial advisers who are very client-focused but have never thought about execution in their lives,” Mr. Nadig said. “They have built their careers around things like [The] Charles Schwab Corp.’s OneSource platform, but now as they are shifting to ETFs, many of them get blindsided by bad execution.”

Failing to get the best prices on trades is sometimes a function of the market, and not the advisers’ fault, Mr. Nadig said. But often it is because they don’t know all of the options available to them, he said.

“Advisers can do a lot of things to keep themselves out of trouble,” Mr. Nadig said.

With regulators’ increased focus on the fiduciary duty of advisers, it’s more important than ever that they do everything they can to ensure they get the best price when trading ETFs, experts said.

“An adviser can’t transfer the responsibility of providing best execution on to me; it’s up to them to get best execution,” said Chris Nagy, a managing director at TD Ameritrade Holding Corp. “They have a fiduciary responsibility.”

Mr. Nagy suggests that advisers create a checklist of questions to ask their broker-dealers to make sure they are getting best execution. That way, if a client ever asks, they have some documentation proving they did their due diligence.

Advisers should ask their trading platforms how they execute trades, how they handle times of volatile market conditions and what happens if an order isn’t executed at the price the adviser thought he or she was going to get.
DIFFERENT STROKES …

Different broker-dealers use different means of executing ETF trades. Schwab has a partnership with UBS Financial Services Inc. Fidelity Investments uses its clearing platform, National Financial Services LLC. TD Ameritrade works with multiple liquidity providers to get the best price, Mr. Nagy said.

While some experts question whether using one firm for all its ETF trades is a good strategy, others say it really depends on the firm.

“With an exclusive relationship, as long as it’s a great firm, you are going to get a good package price,” said Paul Justice, an ETF analyst at Morningstar Inc.

At some broker-dealers, advisers can ask their custodians for reports on how they achieve best execution.

For example, advisers who use TD Ameritrade can go online and view statistics on the quality of the execution on ETF prices the firm is getting. “They can get price improvement statistics and best-execution statistics,” Mr. Nagy said.

While Schwab has discussed the idea of providing post-trade analysis reports for advisers, it doesn’t have a timetable for doing so, said Eric Pollackov, the firm’s managing director for ETF capital markets.

Executives at Schwab and TD Ameritrade said there have been instances in which advisers didn’t get the best execution on their ETFs, and in those cases, the firms attempted to remedy the problem immediately.

Schwab estimates that this happens less than 5% at the time. “We will go back and make corrections if an order isn’t filled at the price [at which] it should have been filled,” Mr. Pollackov said. “This doesn’t happen a whole lot.”

Another option that advisers may not be aware of is that they can go to the liquidity providers themselves if they think they can get a better execution on an ETF trade.

This practice, called trading away, can be useful to advisers, particularly with large orders of less liquid ETFs, experts said.

“The majority of advisers don’t know they can do that,” Mr. Nadig said, noting that the minimum trade for doing this is generally around 10,000 shares.

Mr. Lydon said he doesn’t usually trade away, but he believes that it can be a good option, particularly for very active advisers who trade in less liquid asset classes.

“Also, advisers should know that their custodians won’t be happy with it and may charge a fee,” he said.

TD Ameritrade doesn’t charge advisers a fee for trading away. Schwab’s fees are determined on a case-by-case basis because it’s such a rare occurrence.

One of the biggest mistakes that advisers make when trading ETFs that affects their ability to get the best pricing is using market orders instead of limit orders.

With limit orders, investors can specify at what price they want to buy or sell a security, while market orders take place at the price prevailing when an order hits a marketplace.

“A lot of people are still using market orders, and market orders for the most part may guarantee on execution, but they might not guarantee best execution,” Mr. Pollackov said.
HELPING HANDS

If they need help, advisers can work with ETF providers to navigate the trading nuances of ETFs.

Mr. Lydon said that he learned early on that ETF providers generally are more helpful than mutual fund providers.

In the mutual fund world, advisers often complain that wholesalers just want to sell them products, he said. Mr. Lydon has found that ETF wholesalers are more than willing to educate advisers on how to trade ETFs and get the best prices.

“It’s not about golf balls and T-shirts and trying to get me to buy their funds,” he said. “ETF providers can help you get to the market makers, and if it’s a big-volume trade, they can step in and help execute it very efficiently. It’s a very different mindset than the conventional wholesaler.”


Tags: , , , ,

Post a Comment

Your email is never published nor shared. Required fields are marked *

*
*

Subscribe without commenting