Do you actually understand ETFs?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
Topic Author
StretchArmstrong
Posts: 186
Joined: Fri May 07, 2010 1:55 am
Location: north of the Yukon

Do you actually understand ETFs?

Post by StretchArmstrong » Fri Oct 08, 2010 1:47 am

I have been reading Ferri's book about ETFs, and to put it mildly, they are complex.

Do you actually understand the underlying mechanisms of ETFs and how they function? It would not surprise me at all if investors purchase them and have no idea how they work or why.

Also, I've only met two people who have ever heard of ETFs.

User avatar
White Coat Investor
Posts: 14213
Joined: Fri Mar 02, 2007 9:11 pm
Location: Greatest Snow On Earth

Post by White Coat Investor » Fri Oct 08, 2010 2:25 am

I understand them better than most (although perhaps not most on this forum.)

I know enough to know I don't need them at this time. Most buy and hold investors don't need to ever understand them beyond the basics, because they don't need them to reach their goals.

I thought about switching my whole portfolio to ETFs once, but I couldn't come up with a convincing reason to do so.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

User avatar
DA
Posts: 901
Joined: Sun Sep 30, 2007 8:19 pm

Post by DA » Fri Oct 08, 2010 2:41 am

I know that they trade all day on the stock exchanges, just like individual company stocks.

Now that I have Admiral shares for all my Vanguard mutual funds that's all I'll ever need to know.

livesoft
Posts: 68121
Joined: Thu Mar 01, 2007 8:00 pm

Post by livesoft » Fri Oct 08, 2010 5:13 am

Why not ask people: "Do you understand mutual funds?"?

xerty24
Posts: 4827
Joined: Tue May 15, 2007 3:43 pm

Post by xerty24 » Fri Oct 08, 2010 5:32 am

Better than most I'm sure, but not well enough to run an ETF arbitrage business. I would hazard a guess that essentially no non-professionals really understand these products when you start asking questions like how leveraged commodity or volatility etfs deal with creation/redemption or what is supposed to happen to the ETF when some bizarre corporate reorganization happens. Even the ETF management have occasionally been wrong about which pieces that get spun off end up in the basket as cash vs in-kind.

Wagnerjb
Posts: 7203
Joined: Mon Feb 19, 2007 8:44 pm
Location: Houston, Texas

Post by Wagnerjb » Fri Oct 08, 2010 7:47 am

livesoft wrote:Why not ask people: "Do you understand mutual funds?"?
I agree. For what we care about, an ETF is identical to a mutual fund. Actually, it is a mutual fund - just traded on the exchange.

Best wishes.
Andy

User avatar
dnaumov
Posts: 495
Joined: Tue Jul 27, 2010 6:04 pm
Location: Finland
Contact:

Re: Do you actually understand ETFs?

Post by dnaumov » Fri Oct 08, 2010 7:53 am

StretchArmstrong wrote:Also, I've only met two people who have ever heard of ETFs.
I think I've met maybe two people who are actually investing into ANYTHING. YMMV :)

That being said, I feel I do have enough of an understanding (especially after reading Ferri's book) on the subject to put some of my equity allocation into ETFs, since the mutual fund offerings available to retail investors in Finland are generally horrible.

david99
Posts: 658
Joined: Sat Mar 03, 2007 11:56 am

Post by david99 » Fri Oct 08, 2010 8:24 am

ETFs are much more complicated for the average investor than mutual funds. During the recent flash crash the price of the Vanguard Total Stock Market ETF briefly hit 15 cents!

Buying and selling a mutual fund is easy. Buying and selling an ETF requires more knowledge such as knowing the right kind of trade order to use, liquidity,.... You shouldn't get involved in ETFs if you don't have a good understanding of how they work.

FredPeterson
Posts: 1025
Joined: Fri Jul 10, 2009 8:41 pm
Location: Madison, WI

Post by FredPeterson » Fri Oct 08, 2010 8:36 am

grunch, without knowing what Ricks book is about...

ETFs based on active or indexed mutual funds are not complex or hard to understand.

ETFs that are derivative and/or leverage based are entirely different.

JimHalpert
Posts: 212
Joined: Fri Apr 25, 2008 1:34 pm

Post by JimHalpert » Fri Oct 08, 2010 8:42 am

I think its clear that most people don't understand the additional risks of ETFs versus MFs.

User avatar
baw703916
Posts: 6681
Joined: Sun Apr 01, 2007 1:10 pm
Location: Seattle

Post by baw703916 » Fri Oct 08, 2010 9:00 am

david99 wrote: During the recent flash crash the price of the Vanguard Total Stock Market ETF briefly hit 15 cents!
Darn! I let a great buying opportunity go to waste... :cry:

Brad
Most of my posts assume no behavioral errors.

User avatar
Rick Ferri
Posts: 8925
Joined: Mon Feb 26, 2007 11:40 am
Location: Georgetown, TX. Twitter: @Rick_Ferri
Contact:

Post by Rick Ferri » Fri Oct 08, 2010 9:06 am

Quiz answers:

1. What are three main differences between ETFs with a UIT structure and those with an Investment Company Act structure (ICA)?
Stocks in a UIT pay to a non-interest bearing account while stocks in an ICA fund pay to the fund and are reinvested. A UIT must fully replicate an index while an ICA structure may deviate from the index. UITs have trustees while ICA fund has a board of directors. For clarification, SPY is a UIT will IVV is a ICA.

2. Which ETF structure provides a K1 at year end rather than a 1099 div?
Grantor Trusts. These ETFs are limited partnerships where each shareholders is issues a K1 with annual expenses, annual income, and capital gains. Many ETFs hold futures contact are structured as a Grantor Trust.

3. Which ETF structure can you request a payout in stocks rather than cash? HOLDRS (Holding Company Depositary Receipts)
Exchange-traded receipts representing beneficial ownership of a fixed basket of common stocks in a particular sector or industry. Owners of these securities can choose to have HOLDRS converted to the underlying stocks so that individual shares can be sold. HOLDRS are originated by Merrill Lynch.

Rick Ferri
Last edited by Rick Ferri on Sat Oct 09, 2010 3:39 pm, edited 1 time in total.

ftobin
Posts: 1039
Joined: Fri Mar 20, 2009 3:28 pm

Post by ftobin » Fri Oct 08, 2010 9:33 am

Rick Ferri wrote:3. Which ETF structure can you request a payout in stocks rather than cash?
This is the most interesting of the three questions in my opinion. Coincidentally, it's the only one I know the answer to as well.

FredPeterson
Posts: 1025
Joined: Fri Jul 10, 2009 8:41 pm
Location: Madison, WI

Post by FredPeterson » Fri Oct 08, 2010 10:08 am

Admittedly I can't answer, completely, any of the questions, but I think #2 really is the most important worth knowing for a significant majority of investors as it deals with taxes.

User avatar
Rick Ferri
Posts: 8925
Joined: Mon Feb 26, 2007 11:40 am
Location: Georgetown, TX. Twitter: @Rick_Ferri
Contact:

Post by Rick Ferri » Fri Oct 08, 2010 11:07 am

I'll post the answers Saturday afternoon.

:)

ftobin
Posts: 1039
Joined: Fri Mar 20, 2009 3:28 pm

Post by ftobin » Fri Oct 08, 2010 12:21 pm

Rick Ferri wrote:Which ETF structure can you request a payout in stocks rather than cash?
A little bit of a tricky point here: there is one class of ETF structure that allows for you to get payout in stocks depending on who you are.

User avatar
BlueEars
Posts: 3782
Joined: Sat Mar 10, 2007 12:15 am
Location: West Coast

Post by BlueEars » Fri Oct 08, 2010 4:24 pm

Rick Ferri wrote:I can provide a quiz, if you like.

Sample questions:

1. What are three main differences between ETFs with a UIT structure and those with an Investment Company Act structure?

2. Which ETF structure provides a K1 at year end rather than a 1099 div?

3. Which ETF structure can you request a payout in stocks rather than cash?

Rick Ferri
Hi Rick, I hope you are not implying that I need to know this stuff to invest in Vanguard ETF's. My guess is you will say no.

About 50% of our assets are in ETF's. From what I understand they are pretty safe investments.

The OP's thread seems to hint that complexity might mean they are more dangerous. So are we to really believe that VTV or VOE or VBR are more dangerous then their mutual fund counterparts? Other then placing a limit order at the bid (for sell) or ask (for buy) and doing so during the trading hours that avoid the first half hour or last half hour (as you have suggested), do you really need to worry about pricing any more then funds?

User avatar
Rick Ferri
Posts: 8925
Joined: Mon Feb 26, 2007 11:40 am
Location: Georgetown, TX. Twitter: @Rick_Ferri
Contact:

Post by Rick Ferri » Fri Oct 08, 2010 4:54 pm

My post was about complexity, not danger. As I said many times, there is no danger in highly liquid Vanguard equity ETFs providing you don't need to trade the immediately. Long-term buy and hold investors should never need to trade anything this instant. So, there's no danger from mis-pricing or temporary illiquidity discounts.

Rick Ferri

User avatar
LadyGeek
Site Admin
Posts: 57392
Joined: Sat Dec 20, 2008 5:34 pm
Location: Philadelphia
Contact:

Post by LadyGeek » Fri Oct 08, 2010 5:12 pm

For the basics:

Please see Exchange Traded Funds on the Bogleheads Wiki.
Wiki To some, the glass is half full. To others, the glass is half empty. To an engineer, it's twice the size it needs to be.

User avatar
nisiprius
Advisory Board
Posts: 39267
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Post by nisiprius » Fri Oct 08, 2010 5:22 pm

Rick, I like your quizzes. I think it is very helpful to have benchmarks against which to measure one's degree of understanding.

It could only be subjective but I'd like to see longer--and easier--quizzes designed with the intention that "if you can't score over 60% on this test, you should invest in this thing."
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

JimHalpert
Posts: 212
Joined: Fri Apr 25, 2008 1:34 pm

Post by JimHalpert » Fri Oct 08, 2010 5:42 pm

Rick Ferri wrote:My post was about complexity, not danger. As I said many times, there is no danger in highly liquid Vanguard equity ETFs providing you don't need to trade the immediately. Long-term buy and hold investors should never need to trade anything this instant. So, there's no danger from mis-pricing or temporary illiquidity discounts.

Rick Ferri
Tell that to the poor slob who lost 59% because he was unlucky enough to sell some shares during the flashcrash.

People in retirement may sell shares every month.

And even if "you" (I don't mean Rick - I'm referring to an average investor) know how to properly trade ETFs - does your spouse?

User avatar
stratton
Posts: 11082
Joined: Sun Mar 04, 2007 5:05 pm
Location: Puget Sound

Post by stratton » Fri Oct 08, 2010 7:35 pm

JimHalpert wrote:
Rick Ferri wrote:My post was about complexity, not danger. As I said many times, there is no danger in highly liquid Vanguard equity ETFs providing you don't need to trade the immediately. Long-term buy and hold investors should never need to trade anything this instant. So, there's no danger from mis-pricing or temporary illiquidity discounts.

Rick Ferri
Tell that to the poor slob who lost 59% because he was unlucky enough to sell some shares during the flashcrash.

People in retirement may sell shares every month.

And even if "you" (I don't mean Rick - I'm referring to an average investor) know how to properly trade ETFs - does your spouse?
Somebody didn't use a "limit" order... In that case they found out why "limit" orders exist.

Paul
...and then Buffy staked Edward. The end.

User avatar
Rick Ferri
Posts: 8925
Joined: Mon Feb 26, 2007 11:40 am
Location: Georgetown, TX. Twitter: @Rick_Ferri
Contact:

Post by Rick Ferri » Fri Oct 08, 2010 7:50 pm

nisiprius wrote:Rick, I like your quizzes. I think it is very helpful to have benchmarks against which to measure one's degree of understanding.

It could only be subjective but I'd like to see longer--and easier--quizzes designed with the intention that "if you can't score over 60% on this test, you should invest in this thing."
Oh, I get it. You want me to dummy down the material so you can pass and feel good about yourself. Well, this here Marine Corps officer has never heard of such hypocrisy! It reminds me of a bunch of whining college students I used to teach, "Oh, Mr. Ferri, your class is too hard! Don't make us work. Can't you just pass us because we laugh at your jokes?"

Ahh, civilians. Sure, what the heck. I can do that. :wink:

Rick Ferri

livesoft
Posts: 68121
Joined: Thu Mar 01, 2007 8:00 pm

Post by livesoft » Fri Oct 08, 2010 9:05 pm

Les wrote:....
About 50% of our assets are in ETF's. From what I understand they are pretty safe investments.
I know you didn't mean "safe investments" as in "not risky investments" or US Treasuries, but that's not the way it came out. :)

User avatar
RJB
Posts: 321
Joined: Sun Sep 21, 2008 12:39 pm
Location: /earth

Post by RJB » Fri Oct 08, 2010 9:39 pm

Les wrote: do you really need to worry about pricing any more then funds?
Pricing, you bet. Funds are priced at the end of day at NAV. ETF's can and do trade above and below the Inidicative Net Asset Value.

As one example, go to: https://www.google.com/finance and in the Get Quotes box type in DGS. It should display the WisdomTree Emerging Mkts Small Cp Div Fd,
Then type .IV after the DGS. It should display DGS.IV, WisdomTree Emerging Markets SmallCap Dividend Fund (Intraday Indicative Value
If you then go back to the Google Finance Page, you'll see those two values displayed on the left column and updated throughout the trading day. For this specific ETF, I have seen the ETF priced much higher than the cost of its Indicative Value, or the cost of the underlying stocks.

Ed 2
Posts: 1510
Joined: Sat May 15, 2010 9:34 am

Re: Do you actually understand ETFs?

Post by Ed 2 » Fri Oct 08, 2010 9:46 pm

StretchArmstrong wrote:I have been reading Ferri's book about ETFs, and to put it mildly, they are complex.

Do you actually understand the underlying mechanisms of ETFs and how they function? It would not surprise me at all if investors purchase them and have no idea how they work or why.

Also, I've only met two people who have ever heard of ETFs.
No. No need . Not trying to pretend to be a fancy, hot trader.
Enough for me to understand the Index Funds.
"The fund industry doesn't have a lot of heroes, but he (Bogle) is one of them," Russ Kinnel

natureexplorer
Posts: 4192
Joined: Thu Sep 03, 2009 10:52 am
Location: Houston

Post by natureexplorer » Fri Oct 08, 2010 10:12 pm

I don't understand ETFs. I don't understand mutual funds either. I diversify this lack of understanding by holding both.

User avatar
BlueEars
Posts: 3782
Joined: Sat Mar 10, 2007 12:15 am
Location: West Coast

Post by BlueEars » Sat Oct 09, 2010 9:35 am

RJB wrote:
Les wrote: do you really need to worry about pricing any more then funds?
Pricing, you bet. Funds are priced at the end of day at NAV. ETF's can and do trade above and below the Inidicative Net Asset Value.
...(snip)...
I think you've taken my question too literally. There have been several threads in the past on buying/selling ETF's. Unless the markets are acting very weirdly (like May 6th) ETF's that are fairly liquid seem to trade reasonably. I just look for "normal" bid-ask spreads. What the underlying true values are is a tougher issue. The end of day pricing of funds would seem to have somewhat similar issues -- but I'm no expert on this stuff.

User avatar
Charybdis
Posts: 242
Joined: Sun Apr 25, 2010 4:38 am
Location: Budapest, Hungary

Post by Charybdis » Sat Oct 09, 2010 9:58 am

Synthetic tracking ETFs are even more complicated than "regular" ETFs. So you should also understand how ETFs track the underlying index. Synthetic (equity swap based) replication is very common in the European Union, I don't know about the US.


Physical Replication vs. Synthetic Replication:

http://www.morningstar.co.uk/uk/etfs/et ... cid=324200

User avatar
dnaumov
Posts: 495
Joined: Tue Jul 27, 2010 6:04 pm
Location: Finland
Contact:

Post by dnaumov » Sat Oct 09, 2010 10:59 am

JimHalpert wrote:
Rick Ferri wrote:My post was about complexity, not danger. As I said many times, there is no danger in highly liquid Vanguard equity ETFs providing you don't need to trade the immediately. Long-term buy and hold investors should never need to trade anything this instant. So, there's no danger from mis-pricing or temporary illiquidity discounts.

Rick Ferri
Tell that to the poor slob who lost 59% because he was unlucky enough to sell some shares during the flashcrash.
How is this different from some poor slob who lost 59% because he was selling regular stocks during the flashcrash? Either you know how buying/selling things on a stock exchange works (and don't do stupid things like using market orders and stop/loss orders) or you don't. The issue does not somehow only magically apply to ETFs.

User avatar
nisiprius
Advisory Board
Posts: 39267
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Post by nisiprius » Sat Oct 09, 2010 1:31 pm

dnaumov wrote: Either you know how buying/selling things on a stock exchange works (and don't do stupid things like using market orders and stop/loss orders) or you don't. The issue does not somehow only magically apply to ETFs.
I agree with the point you're trying to make about ETFs. I agree that the "flash crash" is not a valid reason to knock ETFs.

But I don't think what you're saying about market orders and stop-loss orders being stupid is fair. If they had always been considered harmful, I don't think brokerages would make them easy to invoke. They would at least give you stern CYA warnings and make you click an extra checkbox (the way you do if you try to place an ETF order when the market is closed).

If flash crashes are now to be expected from time to time, if they are part of the new normal, then, yes, I and everyone else better learn to place a limit orders or expect to take the consequences. But I don't think that was true before.

By the way, I assume the only reason the "flash crash" did not affect mutual funds is that it didn't happen at the end of the day. The chances that a flash crash will happen at the exact end of the day are no lower than the chances that one will happen at the exact moment you place an ETF order. This gets kind of weird to think about, but it seems to me that mutual fund investors are no more protected against flash crashes than ETF investors. There are so many mental traps in thinking about probabilities that I'm not certain I've got that right, though.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

ftobin
Posts: 1039
Joined: Fri Mar 20, 2009 3:28 pm

Post by ftobin » Sat Oct 09, 2010 1:38 pm

nisiprius wrote:But I don't think what you're saying about market orders and stop-loss orders being stupid is fair. If they had always been considered harmful, I don't think brokerages would make them easy to invoke.
You are assuming alignment of interest. The orders you refer to have a significantly higher profitability likelihood.

User avatar
baw703916
Posts: 6681
Joined: Sun Apr 01, 2007 1:10 pm
Location: Seattle

Post by baw703916 » Sat Oct 09, 2010 1:48 pm

nisiprius wrote:
By the way, I assume the only reason the "flash crash" did not affect mutual funds is that it didn't happen at the end of the day. The chances that a flash crash will happen at the exact end of the day are no lower than the chances that one will happen at the exact moment you place an ETF order. This gets kind of weird to think about, but it seems to me that mutual fund investors are no more protected against flash crashes than ETF investors. There are so many mental traps in thinking about probabilities that I'm not certain I've got that right, though.
Exactly. I've tried to make this point several times in the past when people have expressed "ETF anxiety." Two thoughts: one, in theory, the mutual fund could invoke a fair value correction if pricing went nonlinear right at the close. Although in practice that would be very complicated to actually decide what the fair value should be in such a case. Do you base it on after-hours trading? On asian markets responding to the news that the U.S. markets dropped abruptly by 15% in the last 5 minutes of trading?

Also, I would think that something like a flash crash might actually be more likely right at the close. Part of what happened, as I understand it, is that due to quote stuffing the system couldn't keep up and people were acting on stale prices. Near market close, volume is typically higher in any event, so wouldn't it be more likely for the system not to be able to keep up? If I remember correctly, about half of the total drop in the 1987 crash happened in the last hour of trading. People have often suggested that individual investors try to avoid trading ETFs (particularly with market orders) in the first or the last 30 minutes or so of the trading day.

Brad
Most of my posts assume no behavioral errors.

User avatar
jpsfranks
Posts: 991
Joined: Sun Aug 26, 2007 11:45 pm

Post by jpsfranks » Sat Oct 09, 2010 2:13 pm

nisiprius wrote:By the way, I assume the only reason the "flash crash" did not affect mutual funds is that it didn't happen at the end of the day. The chances that a flash crash will happen at the exact end of the day are no lower than the chances that one will happen at the exact moment you place an ETF order. This gets kind of weird to think about, but it seems to me that mutual fund investors are no more protected against flash crashes than ETF investors. There are so many mental traps in thinking about probabilities that I'm not certain I've got that right, though.
I do not think this is correct, although it depends on what you mean be "affected." The S&P at its low was down 10% or so. If it had closed there broad market funds like VFINX and VTSMX would have closed down the same since they are priced at the NAV according to the underlying securities.

On the other hand many normally heavily traded ETFs like VTI reached much lower lows than the indices would have suggested, -50% or more. Not that many individual stocks saw those haircuts, which is why the index itself was down 10% and not more. So in that sense I offer that the "flash crash" affected ETF prices much more than it could have fund prices. It was at least possible that someone selling an ETF could have gotten ripped off (or gotten a great deal) far away from what they should have gotten based on the index. The same was never true with an open-end fund.

I have mentioned this in a few other threads so I don't mean to drone on about it. I am not by any means against ETFs. They offer definite advantages like generally lower expense ratios and portability across custodians. I just want to make sure that people are aware that there are unique considerations when trading ETFs and there are some pitfalls that need to be avoided that do not affect open-end funds.
Last edited by jpsfranks on Sat Oct 09, 2010 2:17 pm, edited 1 time in total.

ftobin
Posts: 1039
Joined: Fri Mar 20, 2009 3:28 pm

Post by ftobin » Sat Oct 09, 2010 2:15 pm

baw703916 wrote:Also, I would think that something like a flash crash might actually be more likely right at the close.
The NYSE and NASDAQ have much better closing systems than they did in the past, and they are much more efficient at matching interest. Volatility has been significantly dampened.

User avatar
Rick Ferri
Posts: 8925
Joined: Mon Feb 26, 2007 11:40 am
Location: Georgetown, TX. Twitter: @Rick_Ferri
Contact:

Post by Rick Ferri » Sat Oct 09, 2010 3:40 pm

Quiz answers:

1. What are three main differences between ETFs with a UIT structure and those with an Investment Company Act structure (ICA)?
First, stocks in a UIT pay to a non-interest bearing account and paid in cash quarterly while stocks in an ICA fund pay to the fund and are reinvested until quarterly dividends are paid. Second, a UIT must fully replicate an index while an ICA structure may deviate from the index. Third, UITs have trustees while ICA fund has a board of directors. For clarification, SPY is a UIT will IVV is a ICA.

2. Which ETF structure provides a K1 at year end rather than a 1099 div?
Grantor Trusts. These ETFs are limited partnerships where each shareholders is issued a K1 with annual expenses, annual income, and capital gains. Many ETFs hold futures contact are structured as a Grantor Trust.

3. Which ETF structure can you request a payout in stocks rather than cash? HOLDRS (Holding Company Depositary Receipts)
Exchange-traded receipts representing beneficial ownership of a fixed basket of common stocks in a particular sector or industry. Owners of these securities can choose to have HOLDRS converted to the underlying stocks so that individual shares can be sold. HOLDRS are originated by Merrill Lynch.

Rick Ferri

ftobin
Posts: 1039
Joined: Fri Mar 20, 2009 3:28 pm

Post by ftobin » Sat Oct 09, 2010 10:34 pm

Rick Ferri wrote:3. Which ETF structure can you request a payout in stocks rather than cash? HOLDRS (Holding Company Depositary Receipts)
Exchange-traded receipts representing beneficial ownership of a fixed basket of common stocks in a particular sector or industry. Owners of these securities can choose to have HOLDRS converted to the underlying stocks so that individual shares can be sold. HOLDRS are originated by Merrill Lynch.
I'm nitpicking but, if you register as an Authorized Participant and hold enough shares to be a basket you could redeem your non-HOLDRS for the underlyings.

y5a5gdqwty
Posts: 93
Joined: Mon Oct 04, 2010 1:07 am

Post by y5a5gdqwty » Sat Oct 09, 2010 11:51 pm

Hi,

I'm looking at 'TDV' (TDAX INDEPENDENCE 2040 ETF) and see huge bad/ask spread (cannot post a link, see yahoo finance for example) (the information retrieved over the weekend):

Bid: 17.79 x 200
Ask: 398.99 x 800

Out of curiosity, I tried to post a 'buy' order at market value for this ETF and it gave me $398.99 price, whereas it currently trades at $18.77

Please help me understand the following:

1. What does this bid/ask spread mean? Why is it so huge?

2. If I understand correctly, the value of a mutual fund's share corresponds to the values of its underlying stocks. However, the value of ETF can be completely out of sync with respect of its underlying stocks. Isn't dangerous to own ETFs? Wouldn't owing an ETF (even the one above) have same risk as owing a single company stock?

3. As for target-date ETFs, would the liquidity reduce after the target date? For example, if one wants to sell 'Target date 2040 ETF' after the year 2040, would there be many people who want to buy it?

4. Do ETFs have the same legal protection as mutual funds in the case of bankruptcy of the company issuing them? For example, Mutual Funds are set up as separate legal entities, is it the same with ETFs?

5. If inexpensive 'no-load' mutual funds are not available, would it be safe to by a target-date ETF? Which one of the following two ETFs would you suggest: 'TDV' (TDAX INDEPENDENCE 2040 ETF) OR 'TZV' (iShares S&P Target Date 2040)? Are there any other or better alternative ETFs?

Thanks!

User avatar
dnaumov
Posts: 495
Joined: Tue Jul 27, 2010 6:04 pm
Location: Finland
Contact:

Post by dnaumov » Sun Oct 10, 2010 4:31 am

One thing I don't really understand is why the lack of a market maker authorized participant does not trigger an automatic delisting of an ETF and return of capital to the shareholders. Right now it is possible for an ETF to not have a market maker, yet still not be delisted from an exchange, leaving the shareholders in somewhat of a limbo. The fund can be very hard to trade and when the trades do happen, the prices can be completely out of touch with the NAV and the very fact that the trades DO happen sometimes results in the fund not being delisted, making it hard to get your money's worth in a situation like this.

With a traditional mutual fund, the fund company is in most cases required to redeem the shares should a shareholder desire to do so. However in the case of ETFs, the shareholders do not deal with the fund company directly, they deal with market maker authorized participants (and other people buying/selling on the exchange where the fund is listed) but what if there suddenly aren't any?

User avatar
nisiprius
Advisory Board
Posts: 39267
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Post by nisiprius » Sun Oct 10, 2010 6:34 am

Would someone or several people care to assemble a quiz of ten questions about ETFs that are simple enough that any ETF investor ought to be able to get seven right? That is, if you can't get seven of them, then you don't understand ETFs well enough to invest in them.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

livesoft
Posts: 68121
Joined: Thu Mar 01, 2007 8:00 pm

Post by livesoft » Sun Oct 10, 2010 6:48 am

abudanadam wrote:Hi,

I'm looking at 'TDV' (TDAX INDEPENDENCE 2040 ETF) and see huge bad/ask spread (cannot post a link, see yahoo finance for example) (the information retrieved over the weekend):

Bid: 17.79 x 200
Ask: 398.99 x 800

Out of curiosity, I tried to post a 'buy' order at market value for this ETF and it gave me $398.99 price, whereas it currently trades at $18.77

Please help me understand the following:

1. What does this bid/ask spread mean? Why is it so huge?
ETFs do not trade when the market is closed. When the market is closed, you cannot get a valid quote for an ETF. Instead you get a so-called stub quote that is invalid. So this bid/ask spread means that the market is closed and has no relation to the true bid/ask for this ETF.
2. If I understand correctly, the value of a mutual fund's share corresponds to the values of its underlying stocks. However, the value of ETF can be completely out of sync with respect of its underlying stocks. Isn't dangerous to own ETFs? Wouldn't owing an ETF (even the one above) have same risk as owing a single company stock?
If the quote for the ETF is completely out of sync, then it is unlikely that any transactions would take place (though some people let a computer do this and so they get taken advantage of). No buyer would be willing to buy so high and no seller would be willing to sell so low. Otherwise someone could buy or sell the underlying stocks and sell or buy the ETF in an arbitrage play. This would only happen at a time of lack of info such as when the market is closed or when quotes are stacked up like during the flash crash. You decide if this is dangerous or an opportunity to make easy money.
3. As for target-date ETFs, would the liquidity reduce after the target date? For example, if one wants to sell 'Target date 2040 ETF' after the year 2040, would there be many people who want to buy it?
I don't know much how target date ETFs work. I would not ever buy one. I would not use an ETF that did not have good daily volume. That is, the ETF should have lots of buyers and sellers or other people who want to use it.
4. Do ETFs have the same legal protection as mutual funds in the case of bankruptcy of the company issuing them? For example, Mutual Funds are set up as separate legal entities, is it the same with ETFs?
I do not know.
5. If inexpensive 'no-load' mutual funds are not available, would it be safe to by a target-date ETF? Which one of the following two ETFs would you suggest: 'TDV' (TDAX INDEPENDENCE 2040 ETF) OR 'TZV' (iShares S&P Target Date 2040)? Are there any other or better alternative ETFs?
I suggest you forget about target date ETFs, but reserve the right to change my mind.

My advice: Do not use gimmicky ETFs. If you must use ETFs, then use the ETFs that have lots of daily volume that everyone else uses.

Ed 2
Posts: 1510
Joined: Sat May 15, 2010 9:34 am

Post by Ed 2 » Sun Oct 10, 2010 9:02 am

natureexplorer wrote:I don't understand ETFs. I don't understand mutual funds either. I diversify this lack of understanding by holding both.
I wouldn't invest in anything if I wouldn't understand were and why I'm investing.
Not a critic, just an approach when you buy anything.
"The fund industry doesn't have a lot of heroes, but he (Bogle) is one of them," Russ Kinnel

User avatar
Rick Ferri
Posts: 8925
Joined: Mon Feb 26, 2007 11:40 am
Location: Georgetown, TX. Twitter: @Rick_Ferri
Contact:

Post by Rick Ferri » Sun Oct 10, 2010 10:30 am

ftobin wrote:
Rick Ferri wrote:3. Which ETF structure can you request a payout in stocks rather than cash? HOLDRS (Holding Company Depositary Receipts)
Exchange-traded receipts representing beneficial ownership of a fixed basket of common stocks in a particular sector or industry. Owners of these securities can choose to have HOLDRS converted to the underlying stocks so that individual shares can be sold. HOLDRS are originated by Merrill Lynch.
I'm nitpicking but, if you register as an Authorized Participant and hold enough shares to be a basket you could redeem your non-HOLDRS for the underlyings.
That's basically the function of all APs. A select few institutional investors are allowed to create and redeem ETF creation units in-kind with fund management. However, an investor in those ETFs doesn't have that option unless they own HOLDRS. Only then does each investor have the option to take stock or take cash.

BTW, a little know fact of traditional open-end funds is that fund management can opt to pay a large shareholder out in-kind rather than in cash. For example, assume a large shareholder owns 10% of a fund, and the fund manager believes that selling 10% of the fund will create an undue cost or tax burden on the the other 90% of shareholders, then the fund manager can opt to payout the large shareholder in stocks rather than cash. It's then the responsibility of the shareholders to liquidate individual stocks.

Rick Ferri

Topic Author
StretchArmstrong
Posts: 186
Joined: Fri May 07, 2010 1:55 am
Location: north of the Yukon

Post by StretchArmstrong » Sun Oct 10, 2010 1:31 pm

Rick Ferri wrote:Quiz answers:

1. What are three main differences between ETFs with a UIT structure and those with an Investment Company Act structure (ICA)?
Stocks in a UIT pay to a non-interest bearing account while stocks in an ICA fund pay to the fund and are reinvested. A UIT must fully replicate an index while an ICA structure may deviate from the index. UITs have trustees while ICA fund has a board of directors. For clarification, SPY is a UIT will IVV is a ICA.

2. Which ETF structure provides a K1 at year end rather than a 1099 div?
Grantor Trusts. These ETFs are limited partnerships where each shareholders is issues a K1 with annual expenses, annual income, and capital gains. Many ETFs hold futures contact are structured as a Grantor Trust.

3. Which ETF structure can you request a payout in stocks rather than cash? HOLDRS (Holding Company Depositary Receipts)
Exchange-traded receipts representing beneficial ownership of a fixed basket of common stocks in a particular sector or industry. Owners of these securities can choose to have HOLDRS converted to the underlying stocks so that individual shares can be sold. HOLDRS are originated by Merrill Lynch.

Rick Ferri
Thanks for the post. I need to keep reading and researching so one day I can get my quiz score to 33%
natureexplorer wrote:I don't understand ETFs. I don't understand mutual funds either. I diversify this lack of understanding by holding both.
Haha, I got a good laugh out of that one. However, that's probably more common than most would care to admit.

ftobin
Posts: 1039
Joined: Fri Mar 20, 2009 3:28 pm

Post by ftobin » Sun Oct 10, 2010 1:45 pm

nisiprius wrote:Would someone or several people care to assemble a quiz of ten questions about ETFs that are simple enough that any ETF investor ought to be able to get seven right? That is, if you can't get seven of them, then you don't understand ETFs well enough to invest in them.
I think the questions would largely not be specific to ETFs, but to stock trading in general. Until we all have access to VWAP orders, there is much caveat emptor when placing orders in the marketplace. Areas people placing orders should be aware of so they don't fall into traps:
  • market vs limit orders
    held vs not-held orders
    how AON orders are handled
    how MOO/MOC are handled
    how to reading data feeds to determine liquidity
    intraday indicative value
    how stop/stop-limit orders are handled
    Manning, and when it doesn't apply
    differences between market hours and extended hours
It's very unfortunate that people have to be aware of these.

Ed 2
Posts: 1510
Joined: Sat May 15, 2010 9:34 am

Post by Ed 2 » Sun Oct 10, 2010 1:54 pm

ftobin wrote:
nisiprius wrote:Would someone or several people care to assemble a quiz of ten questions about ETFs that are simple enough that any ETF investor ought to be able to get seven right? That is, if you can't get seven of them, then you don't understand ETFs well enough to invest in them.
I think the questions would largely not be specific to ETFs, but to stock trading in general. Until we all have access to VWAP orders, there is much caveat emptor when placing orders in the marketplace. Areas people placing orders should be aware of so they don't fall into traps:
  • market vs limit orders
    held vs not-held orders
    how AON orders are handled
    how MOO/MOC are handled
    how to reading data feeds to determine liquidity
    intraday indicative value
    how stop/stop-limit orders are handled
    Manning, and when it doesn't apply
    differences between market hours and extended hours
It's very unfortunate that people have to be aware of these.

Small addition: Who can beat high frequency trading? Unless you like that killing machine from "terminator" movie.
Ones again: Who can compete with computers, I'm talking about 1/10000000000000000000 of a second speed trading. Just stay in Index Funds and stop dreaming.
For long term we may see many" flush crashes", no doubt. :)
"The fund industry doesn't have a lot of heroes, but he (Bogle) is one of them," Russ Kinnel

Post Reply