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By Scott Burns | 09-21-2010 10:26 AM

Sizing Up Liquidity in ETFs

Schwab's Michael Iachini says investors should dig deeper to truly understand a fund's liquidity, plus offers tips for investing in commodity and China ETFs.

Scott Burns: ETF portfolio tips from the pros.

Hi, there. I am Scott Burns, Morningstar's director of ETF research, coming to you live from Morningstar's premiere ETF Invest Conference.

Joining me today is Michael Iachini, who is a director in Charles Schwab's Investment Advisory business. There Michael oversees a team of analysts that are responsible for selecting and evaluating mutual funds for and ETFs for Schwab Select List and also for their internal model portfolios.

Michael, thanks for joining me.

Michael Iachini: Thanks, Scott.

Burns: So Michael, when advisors are looking for ETFs out there, what is the one thing that right now you think is the most critical missing element in their due diligence process?

Iachini: Well, I think a lot of advisors do a good job on the basics. They will certainly think about what's the cost, the ongoing operating expense ratio of an ETF, and that's good. But a lot of advisors think about liquidity of the ETF in the wrong way. They know they have to be able to trade it and they know they don't want to have high trading cost for their clients, but sometimes advisors might be tempted just to look at the trading volume of the ETF on the exchanges. And really, if you want to understand how liquid an ETF is, you have to consider the liquidity of the underlying stocks or bonds inside the portfolio, and I think some advisors don't go quite far enough in really understanding that liquidity.

Burns: When you guys are evaluating that, when it comes to liquidity, do you have any thresholds or breakpoints that you are using right now to kind of help determine, or at least good rules of thumb that you would give advisors who don't maybe have access to the kind of data and tools that professionals are using?

Iachini: Sure, yes. When it comes to just looking at the ETF's own volume, we do tend to focus on dollar volume rather than just the share volume, and a good rule of thumb is you want to see at least $1 million a day of volume for the ETF that you are trading.

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