By Tom Bradley
By far the most popular topic in the business press these days is ETFs (exchange-traded funds). Not a day goes by without an article on them (and yes, I am planning to write one in the near future).
In all of the commentaries, trading flexibility is put forward as a strong advantage of ETFs compared to mutual funds. As their name implies, ETFs trade on the stock exchange and can be bought and sold throughout the day. If investors want to take advantage of something that is happening in the market, they can act immediately, rather than being forced to wait until the end of the day to get their trade filled at closing prices.
This flexibility sounds good, but it’s important to distinguish for who it is an advantage. For short-term traders who are glued to their screens and moving in and out of the market, ETFs provide a broad-based, liquid vehicle in which to do that. They can express their minute-to-minute market view through ETFs (Note: ETFs now account for a significant portion of the trading volume on the TSX).
For a long-term investor who buys an ETF because of the simplicity and low cost, however, the exchange trading feature is overhyped. There are a few reasons why I say that. First of all, it takes skill to make sure the trade is fair – i.e. the ‘fill’ is at or close to ‘net asset value’. There are plenty of times when market flows and/or a fund’s illiquidity results in a spread between the price and market value. For small, illiquid ETFs particularly, fills can be erratic and quite poor (unfortunately, I’ve had experience with this when doing tax trades).
Trading on the exchange also costs money. There are commissions and/or account fees. Discount brokers don’t charge much, which is good, but they don’t help the client negotiate their way around the trading floor either.
For the vast majority of long-term investors (myself included), buying a fund at a carefully calculated ‘net asset value’ with no commission works far better than having minute-to-minute trading flexibility. There are positive features to some ETFs (Note: there are too many flavours to generalize any more), but trading flexibility is not one of them.