Although ETFs have become more well-known and prevalent among financial circles, there are still a host of misconceptions regarding the products. Incorrect assumptions are made in premium/discount issues, the role of leveraged ETFs in a portfolio, and especially in regards to ETF trading.

Many investors incorrectly assume that volume is the key determinant in a fund’s liquidity. This isn’t true; the underlying volume of securities in the ETF’s basket is the real key for most products.

However, with that being said, a low volume can often promote a wide bid ask spread ratio, which measures the difference between the lowest price investors are willing to sell for and the most buyers are willing to pay for a particular fund or note.

In most of the big ETF products—such as SPY, GLD, or BND—this ratio is extremely small and often times a penny wide in price terms. This means that investors can often get in or out of a product right at the current level without having to adjust their price too much, helped along by volumes that often put the major products on par with many of the top stocks in the country (read Five Cheaper ETFs You Probably Overlooked).

Unfortunately, in obscure products tracking little known or illiquid segments, penny wide spreads are hard to come by. In fact, in the vast majority of products that have less than $10 million in AUM, spreads can be more than 1% and can often stretch to truly prohibitive levels.

This isn’t to say that investors can’t buy these products, just that the total trading costs—due to these spreads—make it nearly intolerable for most. For example, one of the worst offenders—the iPath Long Enhanced MSCI Emerging Markets ETN (EMLB)—is currently seeing (at time of writing) a bid of 74.68 and an ask of 88.90, forcing investors to drastically change their expectations if they want to cycle into this product (see more in the Zacks ETF Center).

While this is an extreme example, a whole host of products have spreads that are still quite wide, especially when compared to their more liquid and easy to trade counterparts. While the most egregious offenders tend to be in the sub $10 million AUM club, there are still a few ETFs that have more than $50 million under management and are suffering from these problems.

Below, we highlight three of these serial offenders so that if investors want to take part in these products they are well aware of the risks involved. Just remember, this isn’t to say that these ETFs need to be avoided just that extreme caution—and a realization that more trading costs will be required—need to be taken into account:

GS Connect S&P GSCI Enhanced Commodity ETN (GSC)

For those looking to make a bet on the commodity space in ETN form, there is GSC, a reasonably popular ETN from Goldman Sachs. The product has over $70 million in AUM and trades about 16,000 shares a day.

Currently, the product is heavily exposed to energy products, with a massive holding in WTI crude (32%), Brent crude (13%), and natural gas (8%). However, beyond this, the product also has a significant agriculture component and puts about 10% to the broad metals segment as well.

Unfortunately, current bid ask spread ratios come in at 1.17% representing a huge cost for investors looking to trade this product beyond the already high 1.25% expense ratio. Clearly, the product is one of the more expensive, less liquid, and heavily concentrated products that are currently available to investors in the commodity space (see Hard Times In Soft Commodity ETFs).

Instead, investors have a wealth of other options in the commodity world which can provide similar exposure without the significant bid ask spread. For example, the PowerShares DB Commodity Index Tracking Fund (DBC) currently has an average bid ask ratio of just 0.03%-- a penny wide spread—which charging less in fees and providing access to a similar host of commodities.  

ETF Securities Physical Asian Gold Shares (AGOL)

In the physically-backed gold ETF space, investors have a host of options. For those looking to have their gold stored in the island nation of Singapore instead of Western nations, AGOL could be an interesting choice.

The product currently has over $70 million in assets but sees a paltry volume of just 790 shares a day, far less than many other funds in the space. However, the expense ratio is quite reasonable, coming in at 39 basis points per year, in line with other products in the space (read Three Best Gold ETFs).

Unfortunately for this fund, the product has the widest average bid ask spread ratio out of any of the physically-backed gold ETFs, even including those that have far less in assets than AGOL. Currently, the spread comes in at about 0.8%, a rate that is nearly four times higher than any other product in the physically-backed commodity ETF world.

Instead, investors have a host of options in this space, several of which are approaching penny wide spreads. In particular, the enormous SPDR Gold Trust (GLD) could be an interesting choice as the product currently sees volume of about 12 million shares a day and has an average bid ask spread of just 0.01%.

iShares MSCI Kokusai Index Fund (TOK)

In one of the more puzzling examples of the average bid ask spread phenomenon, investors shouldn’t look any further than the Japan excluding TOK. This popular iShares ETF has exposure to a host of developed countries from around the world, including the U.S., and has over half a billion in AUM.

However, the product suffers from low trading volume with only about 10,000 shares changing hands each day despite the product’s relatively low expense ratio of 25 basis points. Seemingly, some traders are put off by the ex-Japan global model that this fund incorporates, preferring to trade via any other number of funds instead (see Five Great Global ETFs For Complete Equity Exposure).

In fact, the current bid ask spread ratio average comes in above 0.8% for TOK, a truly remarkable figure given the liquid nature of many of its underlying holdings. Yet with that being said, the product does still have a significant foreign security component including assets in markets such as Australia, Sweden, and Ireland, nations where trading might not be nearly as liquid as in the American market.

While there aren’t a whole lot of direct competitors to TOK, there are still a number of products which can provide similar exposure without such a wide bid ask spread. In particular, ACWI has a spread of just 0.04% while targeting the global markets while Vanguard’s Total World Stock ETF (VT) has a 0.08% spread while charging just 22 basis points a year for its global exposure.

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