Sometimes ETF prices can differ markedly from the indices they're tracking.
Price spikes are to be expected by investors in AIM-listed oil exploration companies but ETF investors can be caught out by them, too, even if the fund in question has billions of pounds of assets under management.
Indeed, neither the size of an exchange traded fund nor the fact the price can often be directly compared to the level of the index it's tracking, seems to offer the ETF investor protection from some mysterious and short-lived lifts and falls. And these are not just the result of the kind of market turbulence that was seen last autumn; price spikes can also come out nowhere.
Example spikes
One recent instance of the problem was db X-tracker DJ EUROSTOXX 50 (LSE: XESX). This fell from £22.79 to a round £20 just for a day on 30 July 2009. The day after it was back up at £23.07. On the day in question, just 479 shares were traded out of the 62 million in issue. This level of trading wasn't unusually low and suggests that even a £1.8 billion fund can be a lot less liquid than one might suppose.
The ETF's opening, high, low and closing prices were all £20 so it looks as if one or more over the counter trade after hours on 29 July may have been the cause of the steep fall rather than the paltry 479 shares that changed hands the following day.
Another example is db X-tracker MSCI World TRN ETF (LSE: XMWD). In addition to a whole series of downward spikes during the midst of the financial crisis, this had a sudden one day lift as recently as 21 September.
The shares went up from $26.79 on opening to $31.25 at the close. This time the spike followed several days without trades with 20,000 shares traded on the day of the spike. Compared to the 61 million shares in issue, this still seems small -- this looks like another ETF with a lot less liquidity than one would expect. By the next day's opening the price was back in the region of $27.
My final example is yet another from the Deutsche Bank stable; db X-tracker Sterling Money Market ETF (LSE: XGBP). In this case, the spikes themselves are very small (a matter of a few pence in the share price) but they happen quite frequently and they are a glaring interruption to the steady but glacially slow returns that this ETF normally earns. Here, the ETF's small size (£31.5m) seems to have been more of a determining factor.
Safety measures
Fathoming the exact cause of a price spike isn't easy and, in any case, the important thing is to take steps to be avoid being caught out.
Most important is to be prepared for a spike situation right from the start and to keep it in mind for the duration of your ownership of the ETF shares. The following are a few suggestions for keeping the risk to a minimum:
- Check how many market makers the ETF has. The fact sheet or fund data on the sponsor's website should give an indication. The accepted wisdom is that more than one market maker makes for more liquidity, lower spreads and helps avoid spikes. That said, for the first two of our three example ETFs three market makers each are listed.
- Check out price charts for any ETF in which you're interested from more than one source. db X-trackers own historical performance charts for our first two examples didn't show the spikes but Bloomberg's and the LSE's did. Pay particular attention to the trading volume data provided.
- Check whether or not your broker allows you to use limit orders for the ETF in question.
- If you're concerned that your investment has some un-ETF-like liquidity issues, avoid trading at the start of the trading day or on days like New Year's Eve.
What spikes mean for ETFs and investors
Spikes look as if they might present opportunities for other investment institutions to pull a fast one by making an arbitrage profit. Presumably, sponsors like db X-trackers are not going to allow that to happen, but the occurrence of price spikes makes me a little more wary of ETFs than I would otherwise be.
Stock exchanges, regulators and ETF sponsors owe us an explanation when such things happen. Periodic spikes that appear to have nothing to do with the behaviour of the underlying assets could chip away at investors' confidence in the whole idea of ETFs.
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