When youre No. 2 in ETF trading, you have to try harder.
Nasdaq, as the No. 2 marketplace for ETFs behind the New York Stock Exchanges electronic platform, NYSE Arca, is known for putting more ideas out there, and right now, its got a proposal pending with the SEC for a new type of order for U.S. equity ETFs called an iNAV Pegged Order. If the SEC gives it the nod, it will be a first of its kind.
With U.S. equity ETFs, their iNAVs, or intraday net asset values, are automatically adjusted every 15 seconds based on the current market value of the stocks in their portfolios.
What the Nasdaq is proposing is that investors be allowed to put in orders pegged to a U.S. equity ETFs most recent iNAV. As the iNAV changes, so move the iNAV Pegged Orders, the Nasdaq stated in its SEC filing, made on October 12. Nasdaq also noted a Pegged Order may have a limit price beyond which the order shall not be executed.
And the point of instituting this order type, Nasdaq said in its pitch to the SEC, is that relative to the current intraday order entry/execution order types, the iNAV Pegged Order type would allow certainty of execution with a greater correlation to the ETFs fair value for those seeking to invest on a more informed basis.
I think its a good idea, says Michael Rawson, an ETF analyst at Morningstar in Chicago. Its like a limit order, but pegged to the current iNAV of a fund, and that makes sense, he says.
But Dave Nadig, the director of research at IndexUniverse in San Francisco, sees a number of potential problems. I think its got its heart in the right place, but the devils in the execution, he says.
First of all, it applies only to the ETFs that are strictly invested in U.S. equities because those are the only ones where its possible to get an intraday NAV that is close to being accurate, he says. Therefore, the ETFs that hold some mix of U.S. and international stocks, or stocks and bonds, would be excluded, and that narrows the list of eligible ETFs to a few hundred, he notes.
Secondarily, most ETFs trade at a spread around iNAV, but not right at iNAV. If, say, the iNAV is 100, its very common for the ETF to be quoted at 99.90 to the seller or 100.10 to the buyer, he says. And Nadig notes, market makers will want to sell at iNAV plus 10 cents because thats how the market works; thats how they make their money. He adds that the risk is that you could miss your trade because youre being very picky and want to get your ETF shares at iNAV.
Whats more, Nadig says,iNAV isnt perfect. He points out that theres no way to keep iNAV from responding to any kind of bad data that gets fed into it, such as a bad print on one stock out of 50 in an ETFs basket.
In its filing, Nasdaq said that in the event that the iNAV data feed for a particular ETF were to be compromised or temporarily stopped being disseminated, the use of the iNAV Pegged Order type for that ETF would be suspended, and orders already in the system would be cancelled.
But, what if it doesnt get cancelled in time, and it gets hit? asks Stephen OGrady, who was the partner in charge of ETF trading at Kellogg Capital Markets, before it was sold to Knight Capital Markets in October 2010. He is now a consultant based in Mountain Lakes, New Jersey.
OGrady notes that if market makers either buy or sell at iNAV, they cannot make any money. Thats because market makers make their profits selling or buying above or below iNAV, and they then hedge their bets by buying or selling the underlying stocks.
Its the obligation of the exchanges to see that the public is getting treated fairly, but the problem is: What is the incentive for the market makers? Theyre the ones who have the money at risk, not the exchange, he says.
But, he also notes most of the complaints about the ETF market are that market orders get screwed. Once the market is open, things can move very quickly, he says. Under the current system, his advice is: Dont put market orders in, and if you do, be prepared to get a price youre not happy with.
So far, no comments have been filed, but the comment period is still open though tomorrow, November 8.