A controlled approach to ETF trading
13 April 2020 | Investing
Commentary by Katie Gouinlock, Head of Capital Markets, Vanguard Investments Canada Inc.
The past several weeks have been challenging, amidst a backdrop of considerable volatility and turbulence in global markets. Consider the fact that in March, North American markets triggered market wide circuit breakers four times, something that had only occurred once since their introduction in 1987.1
At Vanguard, we encourage investors to focus on four key investment principles: goals, balance, discipline, and most relevant to this article, cost – specifically that controlling cost supports successful long-term investment outcomes. In addition to management fees, the costs associated with trading are a core component of the overall total cost of ownership (TCO) of an ETF. Simply put:
TCO = Management Expense Ratio + Trading Costs (Bid-Ask Spread + Commissions)
Vanguard’s ETF Capital Markets team’s focus is to equip clients with the information they need to minimize the trading cost piece of this equation. Among the recent volatility, our team has been particularly focused on educating clients on ETF trading practices. While these practices become particularly important in turbulent markets, they’re good to keep in mind in anytime you’re trading. At Vanguard, we’re focused on investing for the 100% (and that includes 100% of market circumstances).
With that in mind, here’s a reminder of three key approaches to help set you up for success when trading ETFs:
1. Avoid trading near market open.
While you can’t control the market, you can control the time of day you trade. An ETF’s price is derived from the value of its underlying securities. At the open, the market is determining both the value of the ETF, as well as the value of the underlying holdings. As a result, volatility is often elevated and spreads wider. Waiting until markets have settled to trade increases the likelihood that your trade will occur as close as possible to fair value and with lower trading costs.
Don’t just take our word for it, consider the example below of an otherwise uneventful trading day, February 28, 2020. In the first fifteen minutes of trading, the average spread on Vanguard’s FTSE Canada All Cap Canada ETF (VCN) was 10.5 bps. By 9:45AM, spreads had come in considerably, and the ETF was trading at a spread closer to 5.2 bps – the difference here is significant, in fact it’s about the size of the management fee.
2. Trade using limit, not market orders.
When considering the tradeoff between these two order types, it can help to think in extremes – a market order expresses a willingness to buy at infinity or conversely to sell at zero. Limit orders allow you to maintain control of the execution price at which you buy or sell an ETF. Limits are an effective tool in all market conditions, and particularly important in protecting you against erroneous execution.
Don’t leave your execution to chance – unless you have a specific need for market orders, consider using a limit order, and if you’re concerned about execution certainty use a “marketable limit order".
3. For larger orders, consider engaging the services of a trading desk
An ETF has multiple layers of liquidity, which means it is often possible to trade larger volume than is advertised on exchange with minimal market impact. This is particularly true during periods of extreme volatility, where market makers may reduce the size they advertise on exchange.
If your order outsizes the liquidity available on exchange and you have access to a trading desk, we encourage you to engage the desk to assist with execution. A trading desk can advise you on execution strategies, help you seek liquidity for your order to obtain a more efficient execution; this may include connecting with an ETF market maker. My team and I speak with advisors several times a day to help them execute their trades efficiently.
Most clients we speak to find this process isn’t onerous, and often produces superior execution outcomes – time well spent to save valuable dollars!
Commissions, management fees, and expenses all may be associated with investment funds. Investment objectives, risks, fees, expenses, and other important information are contained in the prospectus; please read it before investing. Investment funds are not guaranteed, their values change frequently, and past performance may not be repeated. Vanguard funds are managed by Vanguard Investments Canada Inc. and are available across Canada through registered dealers.
The views expressed in this material are based on the author's assessment as of the first publication date April 14, 2020, are subject to change without notice and may not represent the views and/or opinions of Vanguard Investments Canada Inc. The author may not necessarily update or supplement their views and opinions whether as a result of new information, changing circumstances, future events or otherwise.
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