Low-Asset ETFs Can Be Tradable

August 25, 2010

Someone get Matt some dried frog pills, because he’s lost it.

In his blog earlier this week, Matt called for the closure of 200 more ETFs. Here was his logic:

“The ETF industry works best if investors can trust ETFs to be liquid and to track closely to their stated index. Today, that’s not always the case. There are 213 ETFs with less than $10 million in assets under management on the market today. There are 73 ETFs that traded less than 1,000 shares a day, on average, over the course of the last month. Investors in many of those funds face wide spreads and significant liquidity challenges.”


Hey, I get it: Sometimes funds are too small to be viable anymore, and every morning when I look at the ETF Daily Data, I see the land mines. But to suggest that funds with low average daily volumes or low assets are untradable—and should thus be shot—is flat-out wrong and you know it. In many cases, these are funds that actually serve a valuable function, and whose low visibility could easily be temporary.

Let’s pick a few off the bottom.

The iShares MSCI USA ETF (NYSEArca: EUSA) would likely be at the top of your bullet-in-the-head list. Its 30-day trailing ADV is just 114 shares, and has just over 2 million in assets. And for most investors, its roughly 600-stock portfolio isn’t going to be meaningfully different than an investment in the iShares S&P 500 ETF (NYSEArca: IVV). But for an investor who’s fishing from the MSCI sandbox, consistency across methodologies can be important, so having a “
” bucket to round out a country strategy focused on rotation in and out of developed markets makes sense.

It just may not make sense to Matt.

One of the most interesting things I’ve seen as we’ve been reporting daily flows data is just how resilient some of these small funds are. The leveraged and inverse product lines of ProShares and Direxion, for instance, are littered with small funds that sit dormant for weeks at a time. Then you have a day like yesterday, when the Direxion Daily BRIC Bear 2X ETF (NYSEArca: BRIS) trades 10,000 shares in a market 10 cents wide. Not great, but it’s not exactly time to roll up the carpet and call it a night either.

And it’s not just “whacky” trading vehicles that show this kind of resilience either. The SPDR Barclays Capital Long Term Treasury ETF (NYSEArca: TLO) was until recently a candidate for Matt’s chopping block, with paltry assets and volume. Yet just yesterday, it pulled itself up over the 30 million mark with a $6.25 million net-flows day. Clearly the folks putting that $6 million to work inside TLO are pretty happy the fund exists.

The whole reason these small funds can be both resilient and useful is that they’re ETFs. In a mutual fund, these piddly assets would be a death knell; each fund dying under the weight of fixed costs. But these are ETFs. A $5 million fund in an interesting but out-of-favor niche can sit comfortably for years until it gets its moment in the sun and then overnight, it can be a star. Just look at funds like Vanguard’s Long Term Government Bond ETF (NYSEArca: VGLT).


VGLT Assets


Sure, it’s a new fund, but there’s absolutely no reason to think that this fund might not have lolled along under $20 million in assets for another decade in certain market conditions.

We’re not the ones who get to decide what’s a relevant investment. The market decides, and I wouldn’t have it any other way. If ETF issuers start shutting down every out-of-favor slice of the market, those slices won’t be available when they become relevant. It’s not like you can get an ETF in the market on a whim.

As usual, the lesson for investors is simple: Be careful. Most small ETFs are totally ownable, if you’re smart with your trading.

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