Markets

Big ETF Creations, Tiny Ripples

We track ETF flows every day here at IndexUniverse, and it always amazes and delights me when a fund's assets dramatically expand or contract in one session and there's no fanfare and no price spike, just numbers on a screen.

It's a sign that the creation and redemption mechanism at the heart of every ETF is working as it should.

Take the 77 percent increase in the assets of the First Trust Health Care AlphaDEX ETF (NYSEArca:FXH), on Monday. The fund added $127 million assets, becoming a $293 million fund in a matter of hours.

The price of the ETF was remarkably stable throughout, closing a hair lower on a day the Dow Jones industrial average fell 0.4 percent.

It's almost hard to believe, especially when you consider that the creations amounted to around 17 times the ETFs average daily volume.

Bid-ask spreads, I was told, remained tight and the ETF shares sold consistently at the ask price, meaning that the market maker in the middle of the action made a profit, as should be the case.

I also learned that the trade prompting the creation was a limit order, a fact that makes me grin given that calling for strict use of limit orders in ETF is becoming a bit of a soapbox for me.

Using limit orders means that if the price of the ETF shares had fallen outside of the pre-set parameters, no big creation would have occurred.

In my travels in the ETF industry, I've even heard some argue that limit orders ought to be mandated by regulators in this age of high-frequency electronic trading.

But that's not something I'm prepared to sign onto and, in any case, is a topic for another day.

In the end, the stealthy expansion of FXH is also about the liquidity of the shares in FXH's underlying index.

It's relatively easy for an authorized participant to scoop up the healthcare stocks that make up the ETF without creating a super-obvious commotion that stokes the prices of the underlying shares and, by extension, those of the ETF.

A Tradeless JEM

The other big creation that barely caused a ripple, in the Barclays GEMS ETN (NYSEArca:JEM), happened on Tuesday and is more of a mystery.

The ETN, which tracks an index comprised of 15 emerging market currencies, went from a security with less than $4 million in assets to one with almost $94 million.

The Barcap ETNs are some of the most obscure exchanged-traded products on the planet. I defy you to even find their documentation short of going to the Securities and Exchange Commission (here's a hint, but good luck trying to find it through Google).

It's a security that regularly goes without trading on a given day, and hasn't traded more than a 1,000 shares since February.

But it took in $90 million in new money in one session, and the price didn't go through the roof.

Unfortunately, the price of the ETN during and even before the large creation isn't clear because the fund simply hasn't traded.

So how do you create $90 million without a trade? It's because the shares haven't moved onto the secondary market.

Unlike an ETF with a specific list of Authorized Participants, the Barcap ETNs can be sold over-the-counter directly to large investors or broker dealers, just like General Motors can agree to issue debt directly to a large endowment.

Neither of those types of trades hit the consolidated tape, so they don't show up as "volume." All that Barcap agrees to in its pricing supplements is to use either market or negotiated prices not less than what's available to the public when selling the securities.

In Europe, this kind of over-the-counter trading is the norm between large market makers and large clients. In the U.S. it's by far the exception to the rule, and really something unique to ETNs as far as we've seen.

Don't forget to check IndexUniverse.com's ETF Data section.

Copyright ® 2011 Index Publications LLC . All Rights Reserved.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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