One of the main reasons for long-term investors to buy exchange-traded funds (ETFs) is to cut down on paying management fees. ETFs are also a useful, convenient tool for short-term traders to trade in and out of individual markets or sectors. For these more frequent traders, the bid-to-offer spread – the gap between the buying and selling price of shares in an ETF – has more of an impact on overall returns. On this score, there’s been both good and bad news in recent months.
The good news is that the average cost of dealing in an ETF has fallen steadily over the past year and is now at pre-crisis levels. According to data published by the German Stock Exchange, the average Xetra Liquidity Measure (XLM) – which is used to assess the cost of buying and then selling e100,000 of a given fund – is now around 40 basis points (0.4%) for the 600-plus ETFs listed on the exchange, Europe’s largest.
Compare that to the dark days of the credit crunch. The average XLM hit 1.1% in October and November 2008 as general market liquidity dried up. In other words, it was costing traders more to buy and sell the average ETF in those months than most charge in annual fees. And that’s before factoring in stockbrokers’ commissions. So it’s a good sign that even although overall trading volumes are still some way short of 2007 and early 2008 levels, the cost of trading (measured in terms of bid-offer spreads) is still falling.
The bad news is that you still have to be careful. It can cost a lot more to trade in less liquid ETFs than in the more heavily traded ones. In July 2010 for example, the average bid-offer spread on the db x-trackers Select Frontier ETF in Frankfurt was 5.7%, while the cost of buying then selling the same firm’s EONIA money market ETF was less than 0.01%. And in late 2008, when liquidity was scarce, some emerging-market ETFs traded with spreads of a whopping 20%.
In the UK, the London Stock Exchange tells a similar story. For example, iShares’ MSCI Brazil fund had a weighted average spread of over 5% earlier this month, while the same firm’s FTSE 100 tracker, London’s most heavily traded ETF, had an average difference of just 0.03% between its buying and selling prices. What’s the lesson? It’s worth checking the actual trading costs of a particular fund before you buy, and go for the largest and most liquid option that you can find.
• Paul Amery edits
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