ETF Spreads ARE Important

By Matthew Hougan

Jim Wiandt's allegiance to conventional wisdom in the face of cold, hard data is impressive, Jim.

Your argument that ETF spreads are "MOSTLY about the underlying" has been around for a while. There's even an article in the Yahoo! Finance ETF education center that makes the same argument.

Unfortunately, it doesn't seem to be true.

If, as you suggest, spreads were driven by the liquidity of the underlying, the S&P 500 SPDR (SPY) would have the same average spread as the RevenueShares Large Cap Fund (RWL). After all, they both hold the same 500 stocks. But in my study, RWL had significantly larger spreads. Those have come down substantially since my study was completed, as RWL has established a presence in the market, but they remain 3X as wide.

I'm not saying I know everything involved in determining the average spread for an ETF. But here is what I do know:

• All ETFs with a lot of assets have small spreads.
• All ETFs with significant trading activity have small spreads.
• Some ETFs with liquid underlying have small spreads
• Some ETFS with liquid underlying have large spreads.

Ultimately, investors don't need to understand what determines the spread on any given ETF. But they do need to know that spreads are important, that they vary wildly between ETFs, and that newer, smaller ETFs tend to have significantly larger spreads than more established funds.

Always check the spread before you buy an ETF. If there is a large gap between the bid and the ask, it should be a factor in determining if that ETF is a good fit for your portfolio.