As more advisors embrace ETFs by shifting some of their client assets into the more tax-efficient, typically low-cost, and well-diversified products, we find that ETF trading still requires some education. To help, we turned to some experts within the financial services community.
Why Use Institutional Block Desks
“There are a few best practices that advisors should consider when trading ETFs,” explained Matt Lewis, vice president and head of ETFs implementation and capital markets at American Century. “The number one is for them to use the institutional block desk which their custodial platforms should have as a resource. The institutional block desks are professional traders that have direct access to multiple ETF liquidity providers. These desks will work with the ETF liquidity providers to obtain an efficient execution for all ETF trades.”
For example, the TD Ameritrade/Schwab block desk is a team of institutional traders who work closely with RIAs to identify and mitigate the risk of market impact on large or illiquid ETF and equity trades. They assist clients as they seek to optimize their best execution processes.
The primary function of this block desk is aligning the client’s investment objectives with market conditions. They accomplish this by providing full-service execution coverage and leveraging trading strategies and liquidity sources.
In addition to providing trade support throughout the life of an order, the block desk offers educational resources. RIAs can turn to the block desk when interested in learning more about the ETF ecosystem, the total cost of trades through a post trade review, market structure, and how to utilize the firm’s trading tools and technology to limit the risk of error.
Understanding Primary & Secondary Market Liquidity
According to Thomas Generazio, senior trader on the institutional block desk at TD Ameritrade/Schwab, the most critical aspect to understand is that there are two places to trade ETFs: the primary market and the secondary market. The secondary market is where you can see the price at which you would buy or sell shares on a screen. This market is optimized for small share orders.
The other market available to advisors is the primary market. Generazio noted that this is where a block desk leverages a market maker’s ability to create and redeem shares in order to tap into larger pools of liquidity very close to the bid/offer.
There are many ETFs that trade less than 100,000 shares per day that might still appeal to an advisor. ETF liquidity is truly based on the underlying constituents, and most ETFs have a lot more liquidity than appears in the secondary market. The TD Ameritrade/Schwab block desk has built strong relationships with asset managers to help advisors and improve the trading experience.
Generazio also recommended that advisors “block those orders up!” In other words, whenever an advisor is buying or selling the same security for more than one client — as part of a model allocation change, for example — Generazio’s advice is that they always block that order so that they are accessing the marketplace once and all clients will receive the same price.
Other Helpful Tips For Trading ETFs
Early birds do not get rewarded by trading ETFs, commented Generazio. There is no need to trade at the open, where spreads tend to be wider and price discovery is disjointed. Volume picks up throughout the day. In addition, he suggested that an advisor not expose themselves to time risk. If they can buy or sell immediately with little to no impact on the market price, they should do so. Don’t try to time the market with ETF trade.
In general, Generazio added that advisors should avoid using market orders when trading in that secondary or screen market; this often leads to an advisor ending up with a different price than they expected. Instead, they should try using marketable limit orders.
For example, if the bid is $20.00 and the offer is $20.05, an advisor can put in a marketable limit order that is slightly higher at $20.07 so they are protected from the price rising too much before their trade gets executed.
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