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Zacks Investment Ideas feature highlights: WisdomTree LargeCap Value Fund, ExxonMobil, Apple and Chevron

  Zacks Investment Ideas feature highlights: WisdomTree LargeCap Value Fund,
                        ExxonMobil, Apple and Chevron

PR Newswire

CHICAGO, Oct. 9, 2012

CHICAGO, Oct. 9, 2012 /PRNewswire/ --Today, Zacks Investment Ideas feature
highlights Features: WisdomTree LargeCap Value Fund (AMEX:EZY), ExxonMobil
(NYSE:XOM), Apple (Nasdaq:AAPL), and Chevron (NYSE:CVX).

(Logo: http://photos.prnewswire.com/prnh/20101027/ZIRLOGO)

The Truth About Low-Volume ETFs

Although ETFs have begun to surge in popularity over the past few years, there
are still a few misconceptions about how the products work. While mistakes are
often made when it comes to how to utilize leveraged and inverse funds or
commodity and volatility products in a portfolio, another key aspect of ETF
investing afflicts nearly all investors no matter the product type; volume.

Volume, or the number of shares trading in a particular period, is regarded by
many as the basis for liquidity in the stock world. The more shares that trade
in a particular security, the easier it will be to move in and out of it,
keeping bid ask spreads tight for popular stocks (see the Three Biggest
Mistakes of ETF Investing).

When investors apply this logic to ETFs, the resulting thinking is that high
volume funds are extremely liquid while low volume ones, much like thinly
traded stocks, should be avoided by most. After all, it is only natural to
assume that ETFs are like stocks in this regard as both are exchange-traded
and many ETFs are just baskets of stocks anyway.

However, this isn't always true as, unlike a regular stock, an ETF doesn't
rely on its actual volume to generate liquidity. Instead, an ETF's volume is
dependent on its underlying holdings for its actual liquidity.

Say What?

The above statement is true because of how ETFs are structured and how new
shares are created in a fund. Basically, what is called an Authorized
Participant (AP) can step in and buy up securities in order to create a new
basket of ETF shares, or trade in ETF shares for underlying securities as need
be.

Due to this feature, ETFs often trade quite close to their net asset value
(NAV), since when prices deviate too far—either high or low—the Authorized
Participant can step in to balance the process out. Thus, when ETF prices are
too high compared to the NAV, the AP creates more ETF baskets while when the
ETF prices are below the NAV, the shares are traded in by the AP for the
underlying securities.

The AP profits from the spread differential in this arbitrage-like move, which
also helps to keep ETF prices in line with their NAV so that everyone wins in
this creation and redemption process (read ETFs vs. Mutual Funds).

Why is this important?

This is key because many investors in ETFs were stock buyers first who are now
beginning to see the promise of using exchange-traded funds in their
portfolios. Due to being conditioned to apply stock logic to ETFs, many may be
unfamiliar with the creation and redemption process and assume that if a low
volume ETF isn't trading frequently that it will be unable to be bought and
sold regularly and easily throughout the day.

In other words, while stock volume is limited to the float of the particular
security, ETF volume is limited to the float of all its underlying securities
and the ability of an AP to buy or sell them on an open market. Basically, if
an ETF invests in liquid securities, it will generally be easy to trade,
regardless of the current volume levels you are seeing.

Take for example the WisdomTree LargeCap Value Fund (AMEX:EZY), a product that
has just $30 million in AUM and volume of just 3,000 shares a day. While at
first glance investors might automatically avoid the product, a closer look at
the holdings reveals a different story (read Try Value Investing with These
Large Cap ETFs).

The ETF's top holdings consist of some of the most liquid and widely held
stocks in the U.S., including ExxonMobil (NYSE:XOM), Apple (Nasdaq:AAPL), and
Chevron (NYSE:CVX). All of these stocks trade at least six million shares a
day, how difficult could it be to a build a basket with stocks like those?

Caveat to Low Volume ETFs

With that being said, investors should note that low volume ETFs still face
some issues that their high volume counterparts do not, namely in the form of
bid ask spreads. Low volume funds generally have a wider bid ask spread, a
factor that can add to total costs when compared to their more liquid peers.

This also means that limit orders will definitely be necessary for low volume
ETFs as well. Since the bid and the ask spread is much wider in these funds,
one must set a tight asking price in order to get into a particular security
at a good price (read Two ETFs for the Muddle Through Economy).

Furthermore, not all market segments are created equal and some will
necessarily be more liquid than others. For example, those following large cap
U.S. stocks are likely to have an easy time with the creation and redemption
process, while those that target niche small cap U.S. stocks may find it a tad
more difficult.

Still, no matter the volumes of the funds, similar products tracking like
indexes will probably face comparable issues when it comes to creating and
redeeming baskets of the underlying ETF.

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