In the ETF world, average bid/ask spread is one of the most widely quoted metrics for liquidity. And average bid/ask spread is indeed important when evaluating ETFs. The chart below shows the average bid/ask spread (in bps of closing price) for each of the sixteen ETFs that we use in our Multi-Asset Income strategy on 4/17/2015.
Despite its usefulness, average bid/ask spread cannot entirely capture the complexity of the ETF markets. One of its major downfalls is that it obscures the significant intraday variation that can exist in an ETF’s bid/ask spread. In the next chart, we again focus on data from 4/17/2015. However, this time we plot the bid/ask spread relative to each ETF’s average bid/ask spread throughout the course of the day. For example, a value of 0.5 for VNQ means that the bid/ask spread for VNQ at that point in time was half of its average value.
Bid/ask spread is far from constant throughout the course of the day. More importantly, this variation can have a major impact on performance. Take the PowerShares S&P 500 BuyWrite Portfolio (ticker: PBP) as an example. PBP’s bid/ask spread ranged from $0.01 (5 bps) to $0.14 (66 bps) with an average of approximately $0.06 (28 bps). Put slightly differently, we can expect to pay implicit trading costs of 14bps – half of the bid/ask spread – every time that we trade our PBP position. However, good or bad timing could lead to this cost being as low as 2.5 bps or as high as 33 bps.
Note: While we only present data from 4/17/2015 for simplicity, similar patterns were observed across all days that we studied.