etf liquidity. - schweser 3 pm question

so i got a question wrong because i said liquidity is not a main benefit of an etf. all etfs are not liquid. (or so i thouht) especially with etfs for every freaking style,country and sector from every company being available these days. there are etfs that trade 200 shares a day with a large bid/ask spread. am i looking at this too practically?

I think the point is that even though many ETFs are indeed fairly illiquid, they’re more liquid that whatever the reference stock/asset/index etc that you might be wanting to get exposure to?

i think the liquidity issue stands not only in the volume although that might be the first ideea that comes in your mind rememerr etf’s are just a basket of securities if you want to sell and price goes down more than underlying securities then arbitrageurs will come into play buy the etf low ask for them to be redeemed and sell the underlying stocks i think you need to look at the overall concept

oh man I write like an idiot

no way i get this question wrong again if it pops up on the test. as i was answering the question i was thinking to myself that i was going to be wrong on the concept. oh well. you can also make an argument that not all etfs are diversified, but now i’m getting into the weeds. crap. thanks for the feedback.

Did they phrase it as THE main benefit or a main benefit. I think it’s definitely up there as one of the biggies, like tax benefits, easy/cheap diversification. Was it a Schweser Q?

Sorry didn’t look at the title well enough. Yes it was a schweser q.

it listed a bunch of benefits and i basically left out the choices with liquidity in it and went for the one with just tax efficiency and diversification.

i got it wrong too- i wasn’t aware that ETF’s were good on the tax efficiency side. now we know, and knowing is half the battle!

i think one of the tax benefits is the really low turnover?

in an open end mutual fund, cap gains are passed on to the investor. so if they distribute, you’ve got no choice. with an etf, you choose when to take the gain or loss because you can just sell it like a stock. that’s not on the test. and no, i don’t work for barclay’s.

yes but my point was that etf are passive investments so that means they only sell or buy when the index changes composition other than that it’s just dividends

so do etf companies distribute cap gains/loss when they change composition? i guess they would have to…

yes they do as far as i know they distribute cash dividends - no reinvestment within the etf they even return capital once in a while you can see it on the ishares site they have to distribute everything that is not representing the market/index they are following

plus holding cash would screw with their tracking error so they hold very little

ETFs must distribute cap gains, but few actually need to…not b/c of just low turnover. If there is a difference in the NAV of the ETF and the market price, institutions will step in to take advantage of the arb by buying the underlying stocks of the ETF from the market maker. The market maker will distribute the lowest cost shares of the underlying securities to the institution saving the highest cost basis shares to be held by the ETF (the institution is not taxed)…or so that is my understanding from researching several years ago. I think Barclays has an educational piece on their website that discusses the above (only in more depth and accuracy).

thanks for the info. maybe YOU work for Barclay’s! :slight_smile: