The NYSE has proposed lowering the fee for trading to $0.10/100, or a tenth of a penny per share, or 10 mils. Did you know there’s a booming market where brokers routinely pay eight cents per share or $8.00/100 shares?
What market? Exchange-Traded Funds (ETFs). We’re told that one day the market is plunging on trade fears, poor earnings, geopolitics, whatever. And the next, it surges 430 points on…the reversal of fears.
If you find these explanations irrational, you’re not alone, and you have reason for skepticism. There’s a better explanation. Let’s tie fees and market volatility together. Here is an image from the iShares Core MSCI EAFE ETF (CBOE:IEFA) prospectus showing the size of a standard creation Unit and the cost to brokers for creating one. Divide the Unit of 200,000 shares by the cost, $15,000, and it’s $0.08/share (rounded up). Understand: brokers provide collateral –in this case $12.5 million of stocks, cash, or a combination –for the right to create 200,000 ETF shares to sell to the public. Why are brokers willing to pay $8.00/100 to create ETF shares when they rail at paying $0.30/100 –the current fee–in the stock market?
Because ETF shares are created in massive blocks off-market without competition.
Picture buying a giant roll of paper privately, turning it into confetti via a shredder, and selling each scrap for a proportionate penny more than you paid for the whole roll. The average trade-size for brokers creating IEFA shares is 200,000 shares. The average trade-size in the stock market where you and I buy IEFA or any other stock is 140shares.
ETF market-makers are pursuing a realtime, high-speed version of the corporate-raider model. Buy something big and split it into pieces worth more than the sum of the parts. These creations in 200,000-share blocks I’ve just described are running at nearly $400 billion every MONTH. Create in blocks, shred, mark up. ETF demand drives up all stocks. Everybody wins.
What happens in a DOWN market? Big brokers are exchanging your stocks, public companies, as collateral for the right to create and sell ETF shares. Suppose nobody shows up to buy ETF shares. What brokers swapped to create ETF shares is suddenly worth less, not more, than the shredded value of the sum of the parts. So to speak. Without ETF flows to drive up it up, the collateral –shares of stocks –plunges in value. And the market devolves into desperate tactical trading warfare to offset losses.