One of the things we’ve discussed in the past is that liquidity shouldn’t necessarily be the #1 concern for investors adequately managing their cash flow – at times it can even make for worse investment decisions. However, for those who are concerned about liquidity, and seeking out exposure to alternatives, the mad dash to ETFs may be ill-advised. Consider the following from Reformed Broker:

So with a lower cost, easier mechanics and sometimes even better results, the switch would appear to be a no-brainer (and there aren’t many on The Street, so when we come across one, it’s exciting).

But there’s a problem inherent to active ETFs that precludes this being a simple decision, the age-old chicken-or-the-egg conundrum.

Based on the most recent data I’ve come across, actively managed ETFs make up less than 5% of the entire AUM in the ETF universe.  This makes sense as they are a relatively new concept to begin with.  There aren’t many active products in the ETF world but many fund families are betting on them as the next frontier thanks to brutal competition in the index ETF space (Vanguard may begin running these things for free at some point!).  And so there are quite a few being rolled out by everyone from iShares to State Street to, believe it or not, Fidelity -a firm that sat out the first 5 innings of the ETF game while roughly $1.5 trillion in assets migrated toward the structure (much of which came directly from traditional funds).

The trouble is, none of them are trading any volume to speak of.  And it may be awhile before they do.  Now you can work with your broker’s trading desk or use limits or even communicate with the authorized participants that handle the creation/redemption of these things for new orders – but that doesn’t alleviate the concern of what might happen in a fast market should you need to get out quickly.  You know you’d be able to liquidate a Spyder or a Triple Q in a flash pretty much no matter what kind of size you come to the table with – but an active ETF averaging under 10,000 shares a day?

How confident can you be?

The fund families understand this hesitation on the part of asset allocators like myself – they need to get more people trading these vehicles in order to get more people trading these vehicles.  This is chicken-or-the-egg writ large when you consider how important this line of products may one day become to the providers.

This conversation is particularly salient in the managed futures space. Consider the WisdomTree Managed Futures ETF – its three-month average daily volume is just over 60k, compared to nearly 166 million for the SPDR S&P 500 ETF. How much liquidity do you think you will have in one of these actively-traded alternative ETFs? If you can’t afford the managed account approach to the asset class, we can sort of understand the retail investing approach, but if you can, and liquidity matters to you, why waste your time in an ETF when you could go with much cheaper access through managed accounts and have daily liquidity that isn’t reliant on volume? Food for thought.