Amid this year’s market volatility and our frequent discussions with financial advisors about the particular benefits of ETFs, we thought we would share the most frequently asked questions from recent months.
1. What steps should I take to ensure I’ll get a good fill on an ETF trade?
There are steps a financial advisor can take to increase the chances of receiving best execution on an ETF trade…
- Take note of the ETF’s bid/ask level. If the difference between the bid and ask is small – a few cents or basis points – that’s the first sign that you may get a good fill.
- Compare the number of shares you intend to trade vs the number of shares being offered at the most competitive bid/asks. While this information isn’t always easily available, your firm’s trading system may provide this view into the depth of the book. For example, if you’re trading 500 shares, and the best bid/ask is offered up to 1,000 shares, you’re in a position to get a good fill. Even if you trade a share quantity far below the offered shares at the first layer of liquidity, it’s still best to use a limit order trade, rather than a market order trade, so you know your fill won’t be any worse than the limit level.
- Lastly, when trading a sizable number of shares above those offered in the first layer of the ETF’s book, consider the liquidity of the underlying securities in the desired ETF. If you’re considering a basic large-cap stock ETF, for example, the underlyings are likely quite liquid, and a market maker can probably offer to buy or sell them at an even more competitive price than the on-screen bid and ask.
2. Why are ETFs generally more tax-efficient than mutual funds?
ETFs’ superior tax efficiency is due to their unique creation/redemption process. ETFs create and eliminate shares through a primary market creation/redemption process via an Authorized Participant (AP), typically a large financial firm. New ETF shares are created by an AP who transfers shares of a desired security into the ETF and receives new ETF shares in return. Conversely, to reduce the number of ETF shares, the ETF transfers out (in-kind) shares of securities to the AP, in exchange for ETF shares, which it eliminates. Transferring shares of the ETF out in-kind eliminates the need for the ETF to realize what could be meaningful gains on those securities. Thus the tax efficiency… in the form of a tax deferral. The end investor, however, is ultimately forced to pay appropriate taxes on any price appreciation that occurs when selling ETF shares in the secondary market.
Mutual funds do not create and eliminate shares in this manner. When redeeming shares, the mutual fund sells enough securities from the fund to acquire sufficient cash to cover the redemption. This forced sale often creates a taxable event for the end investor in that calendar year.
3. How do a thinly traded ETF and a thinly traded stock differ when it comes to execution risk?
A thinly traded ETF is generally more liquid than a thinly traded stock. The difference being that an ETF consists of underlying securities, each with its unique liquidity. Market makers of a thinly traded stock are bound by the stock’s current shares outstanding as a source of liquidity. In contrast, a market maker of a thinly traded ETF can examine the underlying holdings and realize they can acquire these securities in the open market to deliver to the ETF in the primary market, in exchange for newly created shares of the ETF for their buyer. The clear operational difference between mutual funds and ETFs accounts for ETFs’ superior liquidity.
4. What prompts financial advisors to use mutual funds vs ETFs vs Separately Managed Accounts (SMAs)?
Mutual funds remain a key vehicle type used in the defined contribution market, since many of the largest recordkeepers administering these plans do not permit ETFs. Mutual funds also tend to be relatively popular in other retirement accounts since tax efficiency is not needed. Outside of the defined contribution and general retirement market, we’ve seen increasing interest from financial advisors to use either SMAs or ETFs. The key reason is tax efficiency. Both SMAs and ETFs are very tax-efficient, with SMAs allowing for security-by-security tax loss harvesting, while ETFs use the previously mentioned creation/redemption process to generate tax efficiency. Some financial advisors prefer ETFs for their ease of trading and no minimum investment requirements, while others choose SMAs for the ability to customize, carefully manage tax loss harvesting, and transport accumulated losses to other accounts.
5. Are ETFs available on most broker-dealers and custodial platforms?
Yes, most ETFs are fully available on competitive broker-dealer platforms. This is particularly true for custodial platforms such as Fidelity, Schwab, Pershing and Envestnet. While wirehouses and independent platforms do offer many ETFs, such firms have recently become more stringent about adding them, frequently requiring a minimum Asset under Management level, average daily volume, and interest expressed by a financial advisor before adding them to their platforms.
We hope these insights are helpful. Please reach out to our ETF team to discuss these and any other questions.
Natixis Active ETFs
Curious to learn more about the unique advantages and characteristics of ETFs, particularly during challenging markets?
- Natixis Loomis SaylesFocused Growth ETF (LSGR)*
- Natixis Loomis SaylesShort Duration Income ETF (LSST)
- Natixis Vaughan NelsonMid Cap ETF (VNMC)*
- Natixis Vaughan NelsonSelect ETF (VNSE)*
* This ETF is different from traditional ETFs – traditional ETFs tell the public what assets they hold each day; this ETF will not. This may create additional risks. For example, since this ETF provides less information to traders, they may charge you more money to trade this ETF’s shares. Also, the price you pay to buy or sell ETF shares on an exchange may not match the value of the ETF’s portfolio. These risks may be even greater in bad or uncertain markets. See the ETF prospectus for more information.
An exchange-traded fund, or ETF, is a marketable security that tracks an index, commodity, bond, or a basket of assets like an index fund. ETFs trade like common stock on a stock exchange and experience price fluctuations throughout the day as they are bought and sold. Short-term fixed income ETFs invest in fixed income securities with durations between one and five years.
All investing involves risk, including the risk of loss. Investment risk exists with equity, fixed income, money market, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided.
The views and opinions expressed may change based on market and other conditions. This material is provided for informational purposes only and should not be construed as investment advice. There can be no assurance that developments will transpire as forecasted. Actual results may vary.
Unlike passive investments, there are no indexes that an active investment attempts to track or replicate. Thus, the ability of an active investment to achieve its objectives will depend on the effectiveness of the investment manager.
Diversification does not guarantee a profit or protect against a loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Asset allocation does not ensure a profit or protect against loss.
There are significant differences between mutual funds, SMAs and ETFs; including, but not limited to, how shares are acquired, costs, and tax efficiency. For ETFs and mutual funds, investors own shares of the fund – for SMAs investors direction own the SMA underlying securities. ETFs and mutual funds are considered pooled investment vehicles in which all investors have the same underlying security exposure in a given product. SMAs grant investors ownership of the underlying securities themselves, which can enable further exposure customization. ETF shares trade on an exchange in the secondary market and price throughout the day, mutual fund shares are not listed on exchanges and only price at the end of the trading day. SMAs hold underlying security shares that mostly trade on exchanges and can be purchased or sold throughout the trading day. An ETF’s investment minimum is merely the market share price, mutual funds can have different share classes where investment minimums can vary and SMAs typically have investment minimums that are higher than both mutual funds and ETFs. From a tax efficiency perspective, SMAs give investors the ability to manage individual securities directly for tax-loss harvesting. ETFs have the ability to take advantage of the in-kind share redemption process and secondary market trading to assist in tax efficiency. Mutual funds have limited ability to enhance tax efficiency due to their share redemption mechanism, though some funds are managed with tax efficiency in mind. Fees can differ across all three vehicles based on the total amount invested, differing acquisition costs, management fees and other factors. Please work with your advisor and consider these differences before investing.
ETF General Risk: ETFs trade like stocks, are subject to investment risk, and will fluctuate in market value. Unlike mutual funds, ETF shares are not individually redeemable directly with the Fund and are bought and sold on the secondary market at market price, which may be higher or lower than the ETF's net asset value (NAV). Transactions in shares of ETFs will result in brokerage commissions, which will reduce returns. Active ETF: Unlike typical exchange-traded funds, there are no indexes that the Fund attempts to track or replicate. Thus, the ability of the Fund to achieve its objectives will depend on the effectiveness of the portfolio manager. There is no assurance that the investment process will consistently lead to successful investing. Fixed Income Securities Risk: Fixed income securities may carry one or more of the following risks: credit, interest rate (as interest rates rise bond prices usually fall), inflation, and liquidity. Below Investment Grade Securities Risk: Below investment grade fixed income securities may be subject to greater risks (including the risk of default) than other fixed income securities. Foreign and Emerging Market Securities Risk: Foreign and emerging market securities may be subject to greater political, economic, environmental, credit, currency, and information risks. Foreign securities may be subject to higher volatility than US securities, due to varying degrees of regulation and limited liquidity. These risks are magnified in emerging markets. Interest Rate Risk: Interest rate risk is a major risk to all bondholders. As rates rise, existing bonds that offer a lower rate of return decline in value because newly issued bonds that pay higher rates are more attractive to investors. Separately managed accounts (SMAs) are investment portfolios owned by an investor and managed by a professional investment firm.
Bid/ask: The term "bid and ask" (also known as "bid and offer") refers to a two-way price quotation that indicates the best potential price at which a security can be sold and bought at a given point in time. The bid price represents the maximum price that a buyer is willing to pay for a share of stock or other security. The ask price represents the minimum price that a seller is willing to take for that same security. Basis point: Basis points, otherwise known as bps or "bips," are a unit of measure used in finance to describe the percentage change in the value of financial instruments or the rate change in an index or other benchmark. One basis point is equivalent to 0.01% (1/100th of a percent) or 0.0001 in decimal form. Fill: A fill is an executed order. It is the action of completing or satisfying an order for a security or commodity. Market order: The term market order, or unrestricted order, refers to an investor buying or selling an investment immediately at the best available current price through a broker or brokerage service. Limit order: A limit order is an order placed with a broker or brokerage service to buy or sell a set amount of a financial instrument at a specified price or better. Unlike a market order, it may not be executed if the price set by the investor cannot be met during a certain time period. Limit level: The specific price used in a limit order to define the most or least an investor is willing to buy or sell a security at. Thinly traded: Thinly traded securities are those that cannot be easily sold or exchanged for cash without a significant change in price. Thinly traded securities are exchanged in low volumes and often have limited numbers of interested buyers and sellers, which can lead to volatile changes in price when a transaction does occur. These securities are also known as being illiquid. Execution risk: Execution is the completion of a buy or sell order for a security. The execution of an order occurs when it gets filled, not when the investor places it. When the investor submits the trade, it is sent to a broker, who then determines the best way for it to be executed. Execution risk would the risk an investor could face when an order is executed at a price not indicative of net present value. Market maker: Market maker refers to a firm or individual who actively quotes two-sided markets in a particular security, providing bids and offers (known as asks) along with the market size of each. Market makers provide liquidity and depth to markets and profit from the difference in the bid-ask spread.
Natixis Distribution, LLC (fund distributor, member FINRA | SIPC) and Loomis, Sayles & Company, L.P. are affiliated.
ALPS Distributors, Inc. is the distributor for the Natixis Loomis Sayles Short Duration Income ETF, the Natixis Vaughan Nelson Mid Cap ETF, the Natixis Vaughan Nelson Select ETF, and the Natixis Loomis Sayles Focused Growth ETF. Natixis Distribution, LLC is a marketing agent. ALPS Distributors, Inc. is not affiliated with Natixis Distribution, LLC.