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By Robert Goldsborough | 09-18-2014 11:00 AM

Dispelling ETF Trading Myths

WisdomTree's David Abner's discusses how investors should think about volume, liquidity, market and limit orders.

Bob Goldsborough: Hi, I'm Bob Goldsborough, an analyst covering passive strategies here on the manager research team at Morningstar. Here with me at the Morningstar ETF Invest Conference is David Abner, who is the head of capital markets for WisdomTree, a publicly traded ETF provider that is known for several kinds of funds, including dividend ETFs, currency-hedged equities ETFs, and also for being an early adopter of innovative indexes.

David is here at the Morningstar ETF Invest Conference to discuss tricks of the trade or tips for retail investors and advisors on how better to trade ETFs. David, welcome.

David Abner: It's great to be back here, Bob. I love the Morningstar Conference.

Goldsborough: David, I wondered if we could start off by talking a little bit about what you think is the single most underappreciated aspect of trading ETFs.

Abner: Underappreciated is easy! Of course, it's the fact that many people think that ETFs need to trade every single day. And they don't appreciate the fact that more and more advisors, in particular, are using ETFs as core pieces of the portfolio. And they don't need to trade every day. They are designed now as investment products, where you put on a position and you hold that position for days, weeks, even months or years.

I think it's underappreciated because people look at the name "exchange-traded funds" and, oftentimes, the first thing they look at is the volume and they say, "This ETF isn't trading every day. It must not be working." It's a complete mistake to look at the funds that way. They are not appreciating the fact that investors don't need to be trading their portfolios every day to be holding good products.

Goldsborough: And you see this as a change for the industry from two, three, four, or five years ago?

Abner: Absolutely. You can look at asset numbers and where those assets are now, in which funds, and what the trading characteristics of those funds are, and you can see that over the last four or five years, we've really done, what I consider to be, a great job at educating people on the mechanics of ETFs. How they work, how they should trade, and how they should implement them into portfolios. There's a lot more to do, of course, on the education side. But you can see in asset growth that people are starting to broaden their use of ETFs. They are moving down the curve. They've gotten over the hump of volume being a restrictive function of the product, and they are really starting to utilize the product set better.

Goldsborough: David, let's shift gears a bit and talk about liquidity. What are ETF investors missing when it comes to understanding liquidity? 

Abner: Liquidity is a great question because people don't realize they make the mistake of looking at volume and assuming that is liquidity. Volume in an ETF does not equal liquidity. The two could not be farther from the same thing. They're not equal. Liquidity of an ETF comes from primarily its underlying basket, the components that the ETF holds, and then a variety of other things: what correlates to it, other futures and options that may be related to it that market makers can use to provide liquidity.

The volume of an ETF is strictly what has traded in that ETF over the past. So, I think we are seeing people now starting to understand that. We are seeing quantitative metrics like the implied liquidity number that show people how to assess potential liquidity in an ETF, and they're getting over the hump in that thinking.

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