Many exchange-traded products that are afflicted with low assets under management (AUM) totals and paltry average daily volume do have at least one thing going for them: Performance. The small, obscure funds clearly do not appeal to investors when it comes to the superficial statistics, but these ETFs pack a punch where it counts, often outperforming larger rivals.
That might be one reason the ETF liquidity argument is starting to be framed in a different light. After all, AUM and ADV do not tell an investor whether an ETF is going to deliver superior alpha.
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Actually, tying an ETF's performance to its AUM is one of the biggest fallacies in the financial markets today. Assuming an ETF is "illiquid" because it sports a small ADV number is not far behind.
"[Volume] is the one that really gets my attention; mainly because ETF ADV is not a true measure of the liquidity of the underlying assets and by default, the actual ETF," wrote Chris Hempstead director of ETF execution services at WallachBeth Capital, in a recent research note. "In its most basic form, simply looking at ADV and dismissing a fund based solely on that metric might steer you away from funds that are quoted in block size at the minimal increment [one penny]."
The unfortunate reality is many advisors and money managers are still focused on superficial metrics such as AUM and ADV. Another reality is that is quite easy to locate small, lightly traded ETFs that are have delivered double-digit returns on a year-to-date basis.
The ETFs featured here had to meet three criteria: Year-to-date returns of at least 10 percent, average daily volume of less than 100,000 shares and less than $50 million in assets under management.
Here is a sampling of what that screen turned up:
Market Vectors Retail ETF (NYSE:RTH) Home to stocks such as Wal-Mart (NYSE:WMT), Amazon (NASDAQ:AMZN), Home Depot (NYSE:HD) and Target (NYSE:TGT), the Market Vectors Retail ETF is not likely to suffer from liquidity issues. To be fair, ADV of about 75,000 shares is decent, but this ETF is surprisingly small regarding AUM. RTH has just $16.3 million in AUM, according to ETFdb data.
Despite its diminutive stature, RTH has jumped 16.2 percent year-to-date, outperforming the far larger SPDR S&P Retail ETF (NYSE:XRT) in the process.
PowerShares Dynamic Financial Sector Portfolio (NYSE:PFI) Perhaps there are just too many ETFs tracking financial services firms on the market today. That might help explain why the PowerShares Dynamic Financial Sector Portfolio is almost six-years-old, but has AUM of just $16.2 million and ADV below 2,800 shares.
As is the case with RTH, PFI's lineup indicates there is little chance this ETF will suffer from liquidity problems. There is a robust market for stocks such as American International Group (NYSE:AIG), US Bancorp (NYSE:USB) and BB&T (NYSE:BBT). PFI is up about 11 percent this year.
SPDR S&P Health Care Equipment ETF (NYSE:XHE) Chances are when a client asks his or her financial advisor about ETFs offering exposure to health care equipment stocks, the advisor recommends the iShares Dow Jones U.S. Medical Devices Index Fund (NYSE:IHI).
Bad call. Year-to-date, over the past year and since the SPDR S&P Health Care Equipment ETF debuted in early 2011, the fund has outperformed IHI. Adding insult to injury is the fact that XHE has the lower expense ratio. Those superlatives are attached to an ETF with less than $17 million in AUM and ADV of less than 22,000 shares. In 2012, XHE has outpaced IHI by 300 basis points.
Vanguard Russell 2000 Growth ETF (NASDAQ: VTWG) The Vanguard Russell 2000 Growth ETF is further proof that even some of the kings of the ETF business sponsor a few funds that struggle to attract large AUM totals. VTWG is also light in the volume category with ADV of just over 5,900 shares.
With $20.2 million in AUM, VTWG is one example of a Vanguard ETF that has not been able to outdo a comparable iShares product. Despite, being five basis cheaper than the iShares Russell 2000 Growth Index Fund (NYSE:IWO), VTWG is nowhere near the size of its iShares rival. IWO has over $3.8 billion in AUM, indicating its 10-year head start on VTWG has proven significant. Both funds are up a bit more than 10 percent year-to-date.
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