ETF headlines are increasingly not about ETFs anymore—they’re about the economy.
Once upon a time, you’d only see that three-letter acronym in articles that specifically dug into what exchange-traded funds are and how they work. Now, every finance story is an ETF story.
It’s not just about China anymore; it’s about GXC and FXI. Every financial press release is followed by a rash of articles proclaiming:“How to play the coming boom in solar-powered juicers with ETFs!”
So it’s understandable, I guess, that more and more people seem to be forgetting that the ”T” in ETF stands for “traded,” and with that “T” comes all sorts of issues generally reserved for stocks. We’ve been covering things like that a lot around here, with the ongoing discussion of assessing fair value a few weeks ago, and the ETF volatility conversation last week.
But there’s a subtlety to all of these discussions that seems to get missed—the importance of “handle.”
Perhaps the cleanest example we have is in gold. As Paul Baiocchi pointed out last year , the battle between the two big gold funds—the iShares Gold Trust (IAU) and the SPDR Gold Shares (GLD) is mostly about price:IAU with an expense ratio of just 25 basis points seems like the obvious choice when compared with the 40 basis points State Street charges for GLD.
Even there, I feel like we often don’t put that cost difference in perspective. Imagine you’ve got a $1 million portfolio and you park 20 percent of it in gold. That’s a $200,000 investment. Over the course of a year, that cost difference of 15 basis points is $300. It’s not the end of the world, but it’s still $300.
So let’s get even more specific, and this is where it gets interesting.
At this morning’s prices, your $200,000 investment is 1,602 shares of GLD, or 15,948 shares of IAU. If you’re a Schwab customer, the GLD round trip will cost you about $16—$8 a trade, going in both directions.
The IAU trade is trickier—technically you might get that round trip for $16, but any trade of more than 10,000 shares puts you in “block” territory, which means they’ll want you to call in and talk to someone.
Your “special” pricing will likely be unique to your relationship with Schwab, but it could default to their “institutional” rate of 1.5 cents per share, which would set you back an enormous $480. You would then complain, and they would likely waive it.
If you’re an active trader, however, it’s likely you’re using a service like Interactive Brokers. IB charges a flat half-a-penny-a-share price, which puts your GLD trade at $16 round trip, while your IAU trade runs you about $160 round trip.
And if you’re a big institution, you can just start adding zeros to all the numbers in the above example.
The low handle has other effects too. Both of the above funds are extremely liquid, and trade right on fair value, day after day. They also trade with penny spreads. The round-trip cost of the spread on the GLD trade is $16.02. For IAU? $159.48.
And there’s one last effect—perceived volatility. Because the minimum price charge for an ETF is always a penny, the measured volatility of the lower-handled ETF is always going to be higher, because a one-penny move is simply a higher percentage of the total share price.
The current 20-day volatility of GLD is 34.1. For IAU, it’s 34.4. Is that “real” in any long-term buy-and-hold analysis? Of course not, but it can cause confusion.
These handle-effects exist throughout the ETF industry.
Vanguard’s S'P 500 ETF (VOO) trades with a handle of $76 versus the S'P 500 SPDR’s (SPY) $167. The iShares Core Total US Bond ETF (AGG) trades with a handle twice as large as the competing fund from State Street, the SPDR Barclays Aggregate Bond ETF (LAG).
This all begs the question, Is a larger handle always better, assuming exposures, risks and expenses are identical? Mostly, yes.
There are really only two arguments for low per-share prices. The first is the retail-investor argument. If the cost of owning one share is only $15, than truly small investors can get more granular in their exposure.
Mostly, I think this argument is specious—after all, Apple’s $400 share price hasn’t deterred many investors.
The second argument is that with a small handle and a 50,000 creation unit size, authorized participants can jump on any mispricing in the shares of an ETF sooner. This—theoretically—could keep the price of a low-handle ETF a bit closer to fair value—and with tighter spreads—than a similar large-handle ETF.
Of course, a smaller-dollar-value basket runs the risk of being less representative of the actual ETF portfolio and inducing some tracking error. In the above example, there’s so much liquidity it doesn’t really matter. But I can see it having some small impact in less liquid ETFs.
The moral of the story here is simple:You can’t assume that share price doesn’t matter. In fact, it can matter enormously. Investors should never forget that the “T” in ETF stands for “traded,” and getting that “T” right is your responsibility, not the ETF’s.
At the time this article was written, the author held a position in IAU. Contact Dave Nadig at firstname.lastname@example.org.
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