With fund companies planning a slew of new exchange-traded funds, investors should take special note. As beguiling as some of these new ETFs may be, some could be tied to indices too esoteric to be adequately liquid. And that could also lead to wide bid/ask spreads, which could mean unfavorable pricing.
This was a repeated note of caution from fund-product execs who spoke at an ETF conference in New York on Thursday. Even while touting the phenomenal growth in ETFs, they repeatedly voiced concern over potentially low trading momentum for some of these new funds.
"There's a prevailing belief that some of these ETFs are like the Roach Motel," said Jay Baker, a vice president with
Spear Leeds & Kellogg
, the market maker for SPDRs, Diamonds and 24 other ETFs. "You can get in but you can't get out."
The reason some of the new types of ETFs may not attract daily trading volume greater than 10,000 shares is because fund companies, anxious to get into the ETF market, are planning more specialized types of ETFs. Some of the new products, for instance, will be based on indices tailor-made for the fund, said Gary Gastineau, managing director at
. Others are likely to be based on specialized industries areas, like semiconductors, said Diane Garnick, equity derivatives specialist with
The trouble with such specialized ETFs is that they may not appeal to enough market makers, specialists and institutional investors, let alone the investing public, to gain adequate liquidity, executives said.
Meanwhile, the ETF granddaddy of them all, the
Nasdaq 100 Index Shares
, recently traded a record 116 million shares, Baker said. Even with the Nasdaq down more than 30% since March 10 last year, a tremendous amount of assets has continued to pour into the QQQ, added Harry Tutwiler, Nasdaq's director of financial product marketing.
released data Friday indicating that the QQQ attracted a whopping $18 billion in net new cash in the fourth quarter, bringing total assets to $23.6 billion. This makes the QQQ the second-biggest ETF next to the
S&P 500 Spider
, which had $25.5 billion of assets at the end of December, according to Strategic Insight. For all of 2000, ETFs and HOLDRs attracted $47 billion in net new flows, bringing the total assets in this asset class to $70.8 billion.
Insiders don't expect nearly the same type of success for some of the new ETFs to hit the market. "It is easy to become disillusioned by
the lack of adequate liquidity," Garnick said. If an ETF doesn't attract enough liquidity, it's very difficult for market makers to trade ETF shares, added Augustin Fleites, a principal with
State Street Global Advisors
Furthermore, ETFs based on indices with annual turnover of as much as 40% of the underlying stocks can result in high embedded capital gains, Fleites said.