Baked in the Cake

Another Look at ETF Premium/Discounts and Spreads

Baked in the Cake

As we noted in a previous article, the liquidity of an exchange-traded fund is not always best measured by the historical trading volume of the fund. A better gauge of an ETF's liquidity is the liquidity of the underlying stocks in the index.

To quantify ETF liquidity, Salomon Smith Barney has conducted several "snapshot studies" that take random pictures of the ETF market to look at bid-ask spreads of domestic and international ETFs. Below are the results of the latest snapshot study conducted in January 2002, when Salomon Smith Barney gathered data from 40 random snapshots taken throughout the month.

Domestic ETFs
Average bid
61,752 shares
Average ask
66,799 shares
Average spread
$0.18
Average spread %
0.330%
Cap-weighted avg. spread
$0.06
Cap-weighted avg. spread %
0.087%
Source: Salomon Smith Barney, Bloomberg, the AMEX
International ETFs
Average bid
13,487 shares
Average ask
15,438 shares
Average spread
$0.19
Average spread %
0.867%
Cap-weighted avg. spread
$0.17
Cap-weighted avg. spread %
0.591%
Source: Salomon Smith Barney, Bloomberg, the AMEX

Salomon also looked at premiums and discounts for the domestic and international ETFs. The tables below show that that the premiums and discounts for ETFs are very small. Not surprisingly, the international ETFs have larger premiums and discounts because the stocks are not as accessible.

Domestic ETF Snapshot study - Premiums/Discounts
 
Bid P/D
Mid P/D
Ask P/D
Average
-0.0937%
0.0067%
0.1069%
Maximum
1.4550%
1.6430%
3.5760%
Minimum
-1.2110%
-0.7010%
-0.5810%
Cap-weighted avg.
-0.0006%
-0.0028%
-0.0050%
Source: Salomon Smith Barney, Bloomberg
International ETF Snapshot study - Premiums/Discounts
 
Bid P/D
Mid P/D
Ask P/D
Average
-0.4753%
-0.0469%
0.3815%
Maximum
2.4603%
2.7778%
3.0952%
Minimum
-3.8961%
-3.3575%
-2.9520%
Cap-weighted avg.
-0.3066%
-0.0110%
0.2846%
Source: Salomon Smith Barney, Bloomberg

The analysts who wrote the report noted that the results improve dramatically each time they conduct the snapshot study. They also said the growth in popularity of ETFs has helped shrink spreads, although the growth in the number of smaller funds has probably had an adverse affect on the overall results.

Additionally, a very competitive market was established in the Vanguard Total Stock Market Vipers (VTI). The managers of other broad-based competitor ETFs have countered by shrinking spreads in their own funds, according to Salomon Smith Barney.

Finally, the New York Stock Exchange is trading several AMEX-listed ETFs, and the addition of more specialists has created increased competition and helped reduce spreads even further.