Your ETF Has ‘DRIP Drag’!

October 21, 2014

Delay Costs

In a rising market, delays push the reinvestment price higher, so reinvestors buy fewer shares compared with what they could have gotten on the ex-date. Over the five years to Oct. 15, 2014, global equities rose 8.30 percent per year. On average, an eight-business-day delay would have translated to a 0.25 percent price rise.

With average dividend yields at 2.5 percent, an eight-day delay would have cost investors an average of 0.006 percent annually. For high-yielding funds like IST, REM and PEX, the impact would have been far higher—and that’s before you factor in trading costs.

Trading Is Never Free

The only way to reinvest ETF dividends is to buy shares on the open market. ETF traders must contend with spreads, premiums and discounts. Brokerage firms’ trades are regulated, so brokerage DRIP clients face additional hurdles.

As of Oct. 15, 2014, the median spread for dividend-paying ETFs was 0.14 percent. This means that an ETF buyer could expect to pay 0.07 percent above the midpoint between the bid and the asking price, on average. If the midpoint turned out to be above intraday net asset value (iNAV)—meaning the fund traded at premium—investors could wind up with a much less efficient execution than what they would get in a comparable mutual fund, if such a thing existed.

But that’s not all. If you trust your DRIP order to a brokerage firm, you lose your ability to work your order, which is to say, to pay less than the posted asking price.

You see, brokerage firms are strictly bound to not manipulate securities prices, so they’re essentially price takers. Although Schwab, Etrade and TD Ameritrade “work” their DRIP orders, they have to demonstrate they’re not setting market prices. Vanguard and Scottrade simply use market orders—they pay the asking price.

Market Order + Opening Bell = Trouble

The market opening can be a bad time for market orders, because sometimes ETFs trade roughly at the opening. Market makers posted wide spreads in IST right after the opening bell, as you can see from this chart, which shows the spreads on IST—the SPDR S&P International Telecommunications ETF—during the first hour of trading on Oct. 1, 2014.


That day, IST’s spreads took about four minutes to drop from 2.47 percent to 0.08 percent, before normalizing around the day’s average of 0.20 percent.

In total, 229 shares traded during that four-minute window—a few odd lots, and a 202-share block. Could the 202 shares have been Vanguard’s DRIP buys? After all, Vanguard buys its DRIP shares at the market open, using a market order.


Find your next ETF

Reset All