The Problem with Being Wealthy 15 comments
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There are many good things about being rich, but wealth also brings some problems. The most obvious problem is how to stay rich in these troubled times. Less obvious for the wealthy, is the fact that they have fewer practical investment vehicles than the average investor.
Just as large institutional investors have a smaller universe of individual stocks they can buy without becoming too big of a factor in the security, wealthy individual investors and smaller non-profit or institutional investors have a smaller universe of funds they can buy without becoming too big of a factor.
There are more established mutual funds of substantial size than there are ETFs of similar size, which argues for mutual funds over ETFs for large investors. However, for those who wish to be in a listed security for intra-day entry or exit (including using automated stop loss orders to protect against large drops in price), mutual funds don’t work.
With ETFs as client mandate, what does work?
We recently performed an analysis for some of our wealthier clients to identify those ETFs they could use in their portfolios without moving the market when they decide to move their money.
Here is what we found.
We made the arbitrary decision that a client would not want to own more than 0.5% of a fund’s total assets, and would not want to have any position that was more than 0.5% of the fund’s average daily Dollar trading volume.
Our database tracks 832 ETFs. Of those funds, this is how many can “handle” positions of various sizes based on the above criteria:
- $10 million position: 5 funds
- $5 million position: 12 funds
- $1 million position: 46 funds
- $500,000 position: 76 funds
- $250,000 position: 97 funds
- $100,000 position: 141 funds
- $50,000 position: 197 funds
- $10,000 position: 335 funds.
Those five funds with the capacity to absorb $10 million positions at or under the lesser of 0.5% of assets or average daily trading volume are:
- SPY (S&P 500) — U.S. large-cap stocks
- QQQQ (NASDAQ 100) — U.S. large-cap stocks
- IWM (Russell 2000) — U.S. small-cap stocks
- EEM (MSCI emerging markets) — emerging market stocks
- FAS (Russell 1000 financials) — 3x U.S. financial sector stocks.
To keep the list in the unleveraged category, we step slightly over our arbitrary limit and add XLF (S&P 500 financials), which can justify about $7.7 million position based on our arbitrary 0.5% screening rule.
Screening Results for Most Liquid ETFs (click image to enlarge)
Nearly 500 of the 800+ ETFs (60+%) are not ready for prime time with just about anybody, and only a handful of ETFs are large enough to accommodate an investor who has $50 million to $100 million or more to invest and who wishes to put $10 million into a single ETF position.
It is true that special manual arrangements can be made through brokers to get into a fund without disturbing it. However, that makes getting out without disturbing the fund a special manual arrangement too, which is not something we would recommend. There are some times when a quick exit is needed, or an exit is needed at a particular price point, neither of which would be achieved by the special arrangement process.
An alternative to mutual funds (which lack stop loss opportunity) would be to purchase more than one fund with the same or near same objective, or to purchase the maximum liquid size in the fund of choice and then purchase a collection of individual stocks from the holdings of that fund. That way liquidity can be maintained and stop loss protection can be applied.
Disclosure: We hold SPY, IWM, and EEM in some managed accounts
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This article has 15 comments:
The block trades of cash for securities or securities for cash is part of the arbitrage function that keeps the price near the NAV, but that only occurs between the ETF and a list of approved large institutions. That is not an option for investors other than the approved institutions.
The manual arrangement is to call your broker and say that you need to to a large trade and then they enter a "not held" order. Most likely they send the order to a large bank, or maybe do it themselves, but the effect is to tell market markers and dealers that there is a block available and then they chip away at it as they can. While the executed orders flow across the tap, the available block does not show up on the Ask and Ask Volume quotes on the computer screen that you or the world can see. It is a quiet, behind the scenes method of feeding stock into the market.
An interesting article...and I'm looking forward to the day when I need to be concerned with where to put my $1m+ positions! ;-)
With an over-leveraged economy, falling real estate prices, a weakening dollar, failing banks, ponzi schemes, and new taxes on the horizon, that leaves a lot of room to get kicked in the shorts.
Is this the history of ETF's, that wealthy people needed diversity, liquidity, and the ability to put buy-points and stop-points in? Or was it more about knowing what's there?
I'm curious about the origins of ETF's. How fast do you think they will grow in market share relative to mutual funds?
The history of ETFs is in great part about blending the intra-day trading capability with Closed-End funds, while approximating the price equals NAV of Open-End funds, as well as the various commercial incentives that go with innovation.
Index mutual funds have given the same "look inside" advantage as ETFs.
The high net worth market did not spur the ETF market, but high net worth investors have been attracted to ETFs for the same reasons as other investors. The problem is that most ETFs are still not of the size that they can absorb large single transactions without moving the price around a lot.
Your 2 conditions of 0.5% amd 0.5% seem a bit overly restrictive. Especially th second one concerning the daily volume.
What is the negative of owning 1-2% of the fund and 10% of the average daily volume? does it not mean that one can exit the position in appx 1 hour if neded?
Applying 2% and 10% would multiply the possibilities by many times, I believe.
If it takes an hour to get out in a normal market with 10% of average daily volume, it may take a much longer time or a big reduction in price to get out in a plunging market. That is not a risk we are inclined to take. A stop loss becomes a market order when triggered. 10% of a normal day's volume in a market order would be disastrous.
Of course, one should make sure that the volume of individual stock purchases does not influence the market unduly, but this is much easier to achieve when you are investing only 5% of your $10M in a particular stock, than trying to fit the whole 100% in an ETF.
We have multiple investors with sufficient assets to take $10 million positions, and the majority of them have no interest in individual stocks. The world is full of all kinds of people with all sorts of profiles. It's just a matter of preferences.
ETFs have become popular and investors ask for them often times, but mutual funds with billions of assets are better suited for very large positions, EXCEPT for the loss of automatic trailing stop loss order capability.
The ultimate question is not is an ETF big enough, but IF funds are the preferred route, what funds are big enough. Mutual funds have more offerings of adequate size than ETFs at this time.
Funds are the poor stepchildren of estate management which get abused by the federal governments system of taxation since they assume the investors don't know one iota about investment. Oftentimes they are 100% correct in that assumption.
If they want commodities they hire someone to take and manage their position or buy gold etc certificates outright.
Really, the types of sophisticated investments wealthy people have access too and the options they have at their disposal far surpasses the choices of the less wealthy. That is one very good reason why the rich tend to get wealthier over time. The rest of us tend to tread water as the taxman sits on our head and beats us silly.
The rich are as diverse as any group, with as many differing preferences and approaches.
The fact is that most of the very wealthy do not manage their own money, so most incur some costs from funds or advisors.
The ideal world of near costless investing you mention only comes true if you manage your own money (which most of the very wealth do not do), and only if the investor confines himself or herself to those assets which are accessible, with adequate public information flow, and in some cases available in minimum sizes that are within their "bite size" (which is not universally the case).
While direct ownership of individual US stocks (including ADRs) is quite feasible for US persons, it is not practical or in some cases feasible for individual investors to purchase stocks or bonds in some of the attractive non-US markets. A fund of some kind is the only realistic way to access stocks or bonds in many countries. In addition to limited access in many countries is basic limited information flow and understanding of local accounting rules, local economies, and the businesses themselves.
In today's global investing world, far more than 50% of all investment opportunities are not available within the US or through a US broker, or with sufficient public information to make rational risk taking by the individual possible – and in some cases only specially anointed institutions are permitted to make purchases. On derivatives front, the knowledge and skills required are very specialized. The fact is that the wide range of asset types investors of all sorts, including the wealthy, is so great that it exceeds the reasonable research and skills level of any individual, professional investor or not. Funds are a practical necessity for many investment purposes, regardless of ones level of wealth, intelligence or time available to manage assets.
There are circumstances where owning individual stocks and bonds make the most sense and circumstances that don't make sense from both the investor's personal perspective and the practical aspects of the markets.
So iShares Emerging Markets could handle the volume you might need for a wealthy client. Since professionals might be deciding to use it for that reason, I am assuming then you would turn your analytical skills on to what's in the ETF and who the manager is, yes?
So might that mean that as as a small investor, I could hope to sort of cruise in the wake of the big guys?
I am tempted to visit Brazil to look at some of the allegedly transparent new companies down there, but it probably isn't going to happen, so I am considering ways I might benefit from the abilities of those who can make the trips involved.
Thanks again.