The risk rating methodology used in the ETF Facts is consistent with that
now being used in the Fund Facts by mutual funds. It uses the 10-year
Standard Deviation (SD) to assign a risk rating based on a five-point
scale, and managers are required to backfill history using proxy data if
the fund does not have a 10-year track record.
This means that risk ratings will now be consistent across all mutual funds
and ETFs. Up until now, this has not been the case, as companies have
arrived at very different ratings for similar products depending on the
methodology and time-frame they used to calculate the rating.
2. ETF expenses
If you thought that the Management Expense Ratio (MER) described all the
fees associated with an ETF, think again. Total ETF expenses consist of the
MER as well as the Trading Expense Ratio (TER). As the name suggests, the
TER includes the trading costs, which are minimal for most passive funds.
In fact, of the ETFs that have filed ETF Facts, about half list the TER as
0% and over 80% have a TER of less than 10 basis points (bps).
However, for some active funds and those using complex trading strategies,
the TER can be quite high. Seven ETFs have a TER north of 50 bps, with the
highest being 1.14%. And almost 8% of ETFs have total ETF expenses that are
at least 20% higher than the MER, and four ETFs have a TER that is actually
higher than the MER.
3. Average trading volume
This is simply the average number of units traded each day over a 12-month
period. Of the ETFs that have filed ETF Facts, this number ranges from over
3 million units per day to 54 units per day. The median is currently
19,000. A lower trading-volume number does not necessarily mean that an ETF
is less liquid, as this is determined mainly by the liquidity of the
underlying holdings. Lower volumes could indicate, however, that an ETF is
not very popular.
Consider, for example, an ETF that invests in Canadian blue-chip equities
using a proprietary quantitative strategy. If the strategy is not popular
with investors, the trading volume could be low despite the fact that the
underlying securities are highly liquid. Volume also has a negative
correlation with bid/ask spreads. So low volume could mean wider spreads,
which increases trading costs.
4. Number of days traded
This shows the number of days that an ETF was traded out of the total
number of trading days, the highest being 250 out of 250 or 251 out of 251,
depending on the time frame. Of the ETFs that have filed ETF Facts, just
over half have traded every day, while about 10% have traded less than 100
days during the year. The smallest number so far is 17 days out of 250,
which works out to less than two days per month.
As with trading volume, this statistic is more a reflection of an ETFs’
popularity than its liquidity. Now this is not to say that an ETF with low
trading volume that does not trade everyday should be avoided, but it is
something that should be considered when comparing potential investments.
5. Average bid/ask spread
This is the average bid/ask spread as a percentage of the bid/ask midpoint
over a 12-month period. The actual calculation is highly complex and
extremely data intensive, but the spread basically tells you the additional
cost associated with a round trip (buy-and-sell) trade. Currently, the
lowest value listed on an ETF Facts is 0.01% and the highest is 2.08%. The
median is 20 bps.
As mentioned earlier, in general, lower volume usually means wider spreads.
However, spreads can also be affected by a number of other factors
including illiquid underlying securities, active and opaque strategies, or
simply a limited number of market makers. For investors, it always makes
sense to use limit orders when trading ETFs, but this is especially true
when spreads are wide.
Brian Bridger, CFA, FRM, is Vice President, Analytics & Data at Fundata Canada Inc. and is a
member of the
Canadian Investment Funds Standards Committee.
Notes and Disclaimers
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