By Matt Hougan
I think Paul Amery's recent feature on liquidity in the European ETF market (“The Liquidity Test”) is one of the most important pieces published on the site recently.
I somewhat disagree with Paul's conclusions, however. I’m not sure that trading costs have actually come down in the European ETF market recently; it seems more that they have normalized after the credit and liquidity crunch of 2008. If you look at this chart of mean and median spreads on ETFs since January 2008, you’ll see that spreads spiked in October 2008 and have since gradually trailed downwards.
click to enlarge
Sure, average costs are down a smidge over the full time period, but that strikes me as noise. If you froze the chart in April of this year, costs would have been flat. And if any sort of credit or liquidity crisis returns, I imagine liquidity issues will return. I don’t get the feeling that on-exchange liquidity has grown enough to create inherent liquidity in many of these ETFs. In the US, many funds trade at spreads that are orders of magnitude tighter than their underlying markets: the iShares Emerging Markets ETF (EEM) is a prime example.
But in Europe, I’m not ready to say that the liquidity gates have been opened yet. In fact, as I look over the report, the overarching message to me is that trading costs in Europe remain stubbornly high.
What does it mean that the average cost of an ETF trade is still 27 basis points? That’s more than the expense ratio of many leading funds.
And on the outside? The idea that it costs 5.7% to trade a frontier markets ETF is astounding. I recognize that these are the costs of assembling the baskets, but I’m sure it filters back into spreads on a day-to-day basis.
My favorite part of the article, however, comes at the end, where you compare the costs of trading ETFs at different issuers. What do you think explains the difference in liquidity for the Japan ETFs?
Baffling, and important…