By Zach Hascoe
This post is relevant to institutional investors interested in trading exchange-traded funds (ETFs) in significant volume. Individual investors do not always have access to liquidity providers to trade ETFs as referenced below.
We answer the same question from clients every day: "It's always easy to get in, but what if I need to get out?" When fear and volatility spike in the marketplace, investors worry that they will not be able to liquidate their investments. This concern is understandable, but it is also important to recognize that ETFs are just a wrapper for underlying investments.
Our Capital Markets team has spent the last five years working with traders, market makers and liquidity providers across the entire ETF trading universe to make sure they understand how WisdomTree ETFs are structured and managed. As a result, the trading community feels more comfortable trading our products in the marketplace and providing block liquidity directly to our client base via the block ETF market. When our clients need instant liquidity, we provide them access through a network of liquidity providers across the ETF landscape.
For example, on March 3, 2014, a client wanted to unwind 277,375 shares of the WisdomTree Chinese Yuan Strategy Fund (NYSEARCA:CYB) (approx. $7,000,000 notional) in one trade. Prior to this trade, the average volume of CYB year-to-date (January 2 - February 28) was approximately 56,000 shares per day, as illustrated in the chart below.
The average daily volume of an ETF can be irrelevant as long as the underlying securities in the ETF have sufficient liquidity. CYB invests in Chinese yuan (CNY) forwards, Chinese yuan in Hong Kong (CNH) forwards and CNH time deposits-all of which are extremely liquid instruments that help CYB achieve its stated exposure. The client's execution is shown below.
The market at the time was 25.25 (bid) - 25.29 (ask) and the client was able to sell the entire block-all 277,375 shares-in one piece on the bid at 25.25. The client traded substantially more shares than the average daily volume for the previous two months. If the underlying securities are accessible and liquid, then that liquidity can easily translate to instantaneous ETF liquidity.
This exemplifies the power of the ETF structure, since the client was able to trade almost 400% of the average daily volume (ADV) in one trade. When we structure and launch our ETFs, we keep close watch on liquidity in the underlying markets that can directly affect the liquidity available in the ETF. The strength of the ETF structure is that it makes average daily volume essentially irrelevant, as long as investors have access to liquidity providers or traders that can transfer the liquidity in the underlying markets into the ETF.
Important Risks Related to this Article
There are risks associated with investing, including possible loss of principal. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. This Fund focuses its investments in China, thereby increasing the impact of events and developments associated with the region, which can adversely affect performance. Investments in emerging or frontier markets are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation and intervention or political developments.
Investments in currency involve additional special risks, such as credit risk and interest rate fluctuations. Derivative investments can be volatile, and these investments may be less liquid than other securities, and more sensitive to the effects of varied economic conditions. As this Fund can have a high concentration in some issuers, the Fund can be adversely impacted by changes affecting those issuers. Unlike typical exchange-traded funds, there are no indexes that the Fund attempts to track or replicate. Thus, the ability of the Fund to achieve its objectives will depend on the effectiveness of the portfolio manager. Due to the investment strategy of this Fund, it may make higher capital gain distributions than other ETFs. Please read the Fund's prospectus for specific details regarding the Fund's risk profile.
Zach Hascoe, Capital Markets
Zach Hascoe began at WisdomTree in August 2010, and works directly with David Abner, Head of Capital Markets. The Capital Markets group is involved in all aspects of the WisdomTree ETFs including product development, helping to seed and bring new products to market, as well as trading strategies and best execution strategies for the client base. Zach works closely with the trading and liquidity community and does analytics on ETF baskets and the capital markets. He is a frequent contributor to the WisdomTree blog on topics related to the capital markets, liquidity, structure and best execution. In addition, he manages the hedge fund relationships for the firm. Zach received a B.A. from Bucknell University and was Captain of the Bucknell Tennis Team.