Expense ratios are a key consideration when deciding to choose one ETF over another, but so is liquidity, according to State Street Global Advisors.
The firm — which introduced the first ETF on the market, the S&P SPDR (SPY) in early 1993 but has a current market share of only 17% — has launched a new initiative to educate investors about liquidity and its impact on the total cost of ETF ownership.
“Depending on your rebalancing frequency, trading costs can significantly accumulate and have a larger impact on the total cost of ownership than any expense ratio difference between two ETFs,” said Matthew Bartolini, head of SPDR Americas Research for State Street Global Advisors, in a statement.
Take an a ETF with an average gross expense ratio of 13 basis points and an average bid/ask spread of 2 basis points that trades twice a month. Its annual trading costs average a total 59 basis points, according to a State Street example. In contrast, an ETF with a 10 basis-point gross expense ratio and an average bid/ask spread of 4 basis points that also trades twice a month has average total trading costs of 102 basis points. The less liquid fund, which costs the investor 43 basis points more, is 73% more expensive.
In its example, State Street is equating liquidity with trading volume, which, in turn, impacts bid/ask spreads. The more volume, the narrower the spread, which can be important for investors who trade frequently or at least twice a month. It’s not as important for investors who trade less frequently.