Overlooking Low-Volume ETFs Can Leave Alpha on the Table
You’ve done your research. You’ve done your due diligence. You’ve determined that a lower-volume ETF may bring better outcomes. Now what?
Don’t Let Low Trading Volume Change Your Mind
With over 450 ETFs that came to market in 2021 and approximately 75% being actively managed strategies, there are more products than ever to consider for your overall portfolio allocations. Many of these new products have unique investment strategies designed to produce outcomes beyond index-based approaches. But these products may not have the trading volume of ETFs that follow traditional indices.
Frequently, indexed ETFs are the first consideration for client portfolios because of their large assets under management size and high trading volume. There is a misperception that new or niche ETFs are inaccessible and trade inefficiently because of their small size, low trading volume and wider spreads.
Don’t let low trading volume1 change your mind if the ETF aligns with your client’s goals.
In reality, low-volume2 ETFs can trade easily with a few simple steps.
Identify the Right ETF Trading Strategy
The on-screen and daily average volume of an ETF does influence the effectiveness of a
trading strategy. Consider the size of the allocation you want to purchase in the ETF.
A preferred route is to take advantage of the traders at your custodian’s institutional trade desk. They have direct access to the ETF liquidity providers who will compete for the order flow and provide an efficient execution.
If you don't have access to an institutional trading desk, limit orders3 are an effective way to trade low-volume ETFs because they help control the price parameters of the purchase. With a limit order, you specify the maximum price where you are willing to buy or a minimum price where you are ready to sell, which protects the requested execution price you have for the ETF. Depending on the size of the trade, it’s best to set the execution price a few pennies below the current best bid (for sells) and above the best offer (for buys).
Don’t Leave Alpha on the Table
There is no reason to pass on a well-constructed ETF. Don’t let volume (what investors can typically see) and a wider spread than a penny sway you from investing in an ETF that you believe will better fit the overall portfolio allocation. We believe the alpha potential over the long term may make up for the spread of the lower-volume ETFs.
Develop a relationship with your custodian’s institutional trade desk. Here are ways the traders can help you efficiently trade ETFs:
- Talk through specific size minimums or requirements before sending the trade.
- Identify the best way to submit the trade.
- Discuss technology requirements for submitting trades.
Note: Some desks charge a fee to place a trade.
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Screening ETFs With Your Investment Goals in Mind
Trading volume is the total number of shares of a security traded during a given period of time.
Typically trading fewer than 10,000 shares a day.
Limit order is an order placed with a bank or brokerage firm to buy or sell a fixed amount of an investment at a specified or better price. Investors can limit the amount of time the order is valid before being cancelled. But if the investor’s specified price cannot be met during the set timeframe, the trade will not be executed. As such, there is no guarantee that a limit order will result in an executed trade.
Alpha is typically used to represent the value added or subtracted by active investment management strategies. It shows how an actively managed investment portfolio performed compared with the expected portfolio returns produced simply by benchmark volatility (beta) and market changes. A positive alpha shows that an investment manager has been able to capture more of the upside movement in the benchmark while softening the downswings. A negative alpha means that the manager’s strategies have caught more benchmark downside than upside.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.