3 ETFs With The Widest Trading Spreads

Tradability in an ETF is a key metric in determining how well it does its job for the investor. The ability to get in and out intraday is one of the defining features of the exchange-traded wrapper, but there are several ETFs in the market that struggle with execution due to poor liquidity and low asset volume.

Poor tradability is best seen in average trading spreads—the wider the spread, the more it actually costs an investor to own a fund, and the more careful an investor has to be with order placement.

The three ETFs with the widest trading spreads today, excluding ETNs, are:

• Market Vectors MSCI Emerging Markets Quality (QEM | F-75) – average trading spread of 7.23 percent; total assets: $10.1 million
• KraneShares CSI New China (KFYP | D-24) – average trading spread of 6.92 percent; total assets: $3.3 million
• Falah Russell-IdealRatings US Large Cap (FIA | D-88) – average trading spread of 5.88 percent; total assets $1.3 million

Lack of tradability isn’t necessarily linked to performance, although the performance chart below shows in its long-straight lines just how little these funds trade:

Chart courtesy of Stockcharts.com

“Funds like this suffer because of the Catch-22 of tradability,” Dave Nadig, head of ETFs for FactSet, told ETF.com, noting that the vicious cycle of illiquidity goes something like this: “Nobody really wants these funds as evidenced by assets under management, so nobody trades them. Nobody trades them, so authorized participants and market makers basically ignore them. Since the market makers ignore them, they insert what are essentially stub quotes, so they advertise enormously wide. Because they advertise wide, nobody wants to trade them.”

“The only way this cycle is broken is generally when some ‘event’ makes them ‘hot’ and investor interest picks up,” Nadig added.

A Closer Look

QEM, which came to market about 18 months ago, tracks an index of emerging market companies with high, stable earnings and low leverage. The index is weighted by a combination of these factors and market cap.

The concept is certainly viable, offering investors the opportunity to focus on quality emerging markets that show solid growth potential. But investor interest has been lacking, and as spreads widen, the cost to own this fund rises.

With an expense ratio of 0.50 percent, a spread of 7.23 percent puts total cost of ownership of this fund at about $773 per $10,000 invested. That high price tag has to be made up in performance, and broad emerging market strategies haven’t necessarily been delivering outsized gains.

Underperforming & Illiquid
QEM’s main competitor, the iShares MSCI Emerging Markets Growth ETF (EGRW |D-97) has also been suffering from lack of liquidity, with an average trading spread of 5.79 percent and total assets barely exceeding $10 million. iShares has decided it will shutter the three-year-old fund, which is expected to close Aug. 21.

KFYP is another novel idea, offering the unique concept of a portfolio that invests in Chinese companies deemed to benefit from China's current “Five-Year Plan.” As ETF.com Analytics puts it, “KFYP could be an alternative option to traditional beta indexes for investors hoping to piggyback on the Chinese government's centrally planned economic initiatives; however, poor liquidity limits access to the fund.”

To own KFYP today, an investor would face a 6.92 percent average trading spread and a 68 basis point expense ratio, putting total cost of ownership of the fund at about $760 per $10,000 invested. The fund is up little more than 1.5 percent year-to-date.

Finally, there’s FIA—a one-of-kind U.S. large-cap equity ETF that’s the only fund in the market today that’s Shariah-compliant. It starts out with the Russell 1000 and cuts out about half of the companies in the index to pick only companies that are compliant with Shariah principles. The portfolio tilts away from financials and industrials companies and toward technology and health care firms, according to ETF.com Analytics.

In a market that’s full of large-cap U.S. funds, FIA’s only distinguishing trait is its alignment with Shariah principles, but investors have not bought into the nine-month-old fund yet. Owning FIA today costs about $658 per $10,000 invested. The fund’s expense ratio is 70 basis points.

Incentive To Launch Bespoke ETFs

These new-idea ETFs’ struggle with liquidity and tradability is something issuers and new-to-market ETFs take seriously.

“It’s part of the reason we now see so many funds launch with ‘bespoke’ assets already in the queue,” Nadig said. “Market makers are much more likely to keep a tight market on a low-volume fund if there is at least a large asset base. That’s why a fund like VIDI, which often has extremely low volume, still manages to show relatively reasonable spreads.”

The Vident International Equity ETF (VIDI | F-67) seeks companies it believes show the best growth prospects based in part on the economic, fiscal and political environment of each country, all in a strategy that’s designed to capture excess long-term returns relative to market-cap-weighted funds. The firm frames its unique approach as “principled investing.”

The fund had the backing of Ronald Blue & Co., a principles-based financial advisory shop based in Atlanta, with more than $7 billion in assets under management, from the get-go. The advisory helped develop and launch the ETF, looking to provide a vehicle that would deliver better outcomes for clients while aligning with the firm’s overall values.

“By having an anchor client in place, ETFs can quickly gain the kind of critical mass required to attract external investors, many of whom require an ETF to have $100 million in assets or more to invest,” Matt Hougan, CEO of ETF.com, said at the time of the launch.

VIDI has $740 million in assets, and it trades with an average spread of 49 basis points.