ETF Market Makers Struggled Last Week

In this article I address poor market making in two PowerShare ETFs and how you can protect and correct poor execution.

Last week PowerShares S&P 500 BuyWrite Portfolio (PBP) experienced extremely poor execution on two trades. On Friday September 19^th, 4,000 shares traded at $400 then executed down closer to its NAV price of 24. PBP then traded 929 shares at $300. It then resumed trading closer to its NAV of 24.

My attention was originally drawn to the poor market making because of our position in PowerShares Emerging Markets Sovereign Debt Portfolio (PCY). It also experienced erratic trading. Calls to PowerShares last week about PCY yielded nothing. Their reps had no idea why it was trading erratically and never called us back with an answer.

Therefore, in my search for answers I decided to review the PowerShares Prospectus for this ETF. I found the following risk disclosures:

“Market Trading Risk - Risk is inherent in all investing. An investment in the Fund involves risks similar to those of investing in any fund of equity securities traded on exchanges. You should anticipate that the value of the Shares will decline, more or less, in correlation with any decline in value of the Underlying Index.”

“Additional Risks – Fluctuation of Net Asset Value - The NAV of a Fund’s Shares will generally fluctuate with changes in the market value of the Fund’s holdings. The market prices of the Shares will generally fluctuate in accordance with changes in NAV as well as the relative supply of and demand for the Shares on the AMEX, the NASDAQ or the NYSE Arca. The Adviser cannot predict whether the Shares will trade below, at or above NAV. Price differences may be due, in large part, to the fact that supply and demand forces at work in the secondary trading market for the Shares will be closely related to, but not identical to, the same forces influencing the prices of the stocks of a Fund’s Underlying Index trading individually or in the aggregate at any point in time.

However, given that the Shares can be purchased and redeemed in Creation Units (unlike shares of closed-end funds, which frequently trade at appreciable discounts from, and sometimes at premiums to, their NAV), the Adviser believes that large discounts or premiums to the NAV of the Shares should not be sustained.” – A complete prospectus can be obtained on powershares.com.

After reviewing the prospectus I did not feel that it adequately disclosed the risks or possibility of extremely poor execution. Therefore this week I called PowerShares to inquire further about the erratic trading in PBP and PCY and they finally had an answer: They informed me that some of the market makers in their funds had executed trades poorly amidst the heavy trading volumes last week. They ended up busting the trades that were executed poorly to give fair and accurate pricing of PCY intra-day value to the market.

PowerShares also informed me that they would review on a case-by-case basis the execution of trades that are far away from their ETF’s intra-day values. The representative I spoke with suggested that before placing trades in their funds I should check to see if the ETF is trading near its intra-day.

Obviously limit orders are important and would have prevented some of the issues that occurred in the trading of these two ETFs. In addition you can be more certain of accurate pricing by reviewing the intra-day values of an ETF before you trade.

Example: in Yahoo Finance the ticker for PCY’s intra-day value is “^PCY-IV”.

Last, if you experience extremely poor execution, call PowerShares and notify them of the error. They may be able to assist you in correcting it.

Disclosure: The author’s firm has positions in the following PowerShares ETFs: (PSP), (PFP) and PCY.

Comments

[ETF Investor:]

That was a problem with NYSE Arca for many ETFs, that caused huge price discrepancies. It was an Arca problem and all the trades were cancelled.

2008 Sep 23 05:58 PM

[Gregory Ski...:]

ETF Investor - Thanks for the informative comment.

2008 Sep 23 06:05 PM