Do These ETFs Really Have Liquidity Problems?

Since the start of August, Direxion, Scottrade's FocuShares and Russell Investments have announced closures for a combined 49 ETFs. In other words, it is no secret that ETF closures are on the rise.

Nearly all ETF closures boil down to one of two reasons and sometimes fall victim to both. The reasons are a lack of assets under management and/or anemic average daily volume.

Some financial advisors and money managers have overtly acknowledged they stay away from low-asset, thinly traded ETFs due to perceived liquidity risks. This is interesting, given that it has been documented that these products do offer upside and plenty of them outperform larger, more heavily traded counterparts.

Arguably, part of the problem regarding why so many advisors avoid thinly-traded ETFs is confusion over the difference between volume and liquidity. Volume is the measure of how many shares in a security change hands, whereas liquidity is a measure of the degree to which a market can be made in a security without significantly impacting price.

Simply put, and this is particularly true of equity-based funds, an ETF can have low volume itself, but still be deemed liquid as long as there is a robust market for its underlying components. The following ETFs highlight the fact that a fund need not have jaw-dropping volume to be considered liquid.

Guggenheim Russell Top 50 ETF (NYSE:XLG) With average daily volume of less than 45,000 shares, XLG is not going to win any volume beauty pageants. However, the ETF trades around $105 and that means the average daily dollar volume is north of $4.7 million, adding some degree of comfort for those that obsess over volume.

Importantly, XLG has $538.1 million in assets under management. More importantly, XLG's top-10 holdings, which combine for about 41 percent of the fund's weight, are all liquid. It is possible to transact large orders in stocks such as Apple (NASDAQ:AAPL) or Exxon Mobil (NYSE:XOM) without having a profound impact on price.

Bid/ask spread at this writing: five cents.

SPDR Global Dow ETF (NYSE:DGT) Like XLG, the SPDR Global Dow ETF is a broad market fund, but the SPDR offering takes an international approach. Combine that with average daily turnover below 4,200 shares and skittish volume aficionados are apt to eschew this fund.

Home to about 150 stocks, DGT allocates nearly 48 percent of its weight to U.S. large-caps, alleviating some of the liquidity concerns right there. Beyond that, DGT's international holdings are by no means obscure. It is not hard to move large orders through stocks such as BP (NYSE:BP), Royal Dutch Shell (NYSE: RDS-A) and Taiwan Semiconductor (NYSE:TSM). In other words, DGT's volume stinks, but its liquidity is fine.

Bid/ask spread at this writing: 20 cents.

WisdomTree Total Dividend Fund (NYSE:DTD) For as popular as dividend ETFs are these days, not all of them are heavily traded. The WisdomTree Total Dividend Fund is a prime example of that, but it should be noted the fund has almost $298 million in assets under management.

Perhaps DTD has become a buy-and-hold ETF for income investors because average daily volume is less than 26,800 shares. DTD is home to about 880 stocks and its top-20 holdings account for over a third of the fund's weight. All 20 of those names are sufficiently liquid and some, think Exxon Mobil and Microsoft (NASDAQ:MSFT), are among the most heavily traded U.S. stocks.

Bid/ask spread at this writing: four cents.

Market Vectors RVE Hard Assets Producers ETF (NYSE:HAP) Like DTD, the Market Vectors RVE Hard Assets Producers ETF faces a crowded field as there is no shortage of materials ETFs on the market. And like DTD, HAP is home to a massive number of stocks, in this case, 353. HAP's top-10 holdings account for over a third of the fund's weight. Combine the top-20 holdings and there is roughly half of the ETF's overall weight.

The point is all of HAP's top-20 constituents are heavily traded stocks so even though the ETF itself has volume of less than 29,000 shares per day, the fund cannot be described as "illiquid."

Bid/ask spread at this writing: 10 cents.

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