As far as what is inside an ETF is concerned, you do find that some investors prefer ETFs that buy shares, as opposed to holding swaps. Also, I think that some people don't realize that there are ETFs that do one or both of these things and don't understand the differences, since they assume that funds simply buy shares. So it really comes down to the knowledge base of the investor and how the product is being positioned, marketed and sold by whomever is doing that. While some people prefer their ETFs not to have swaps, others see the benefits of having reduced or no tracking error from using swaps. So, there are pros and cons in both methods of ETF construction.

IU: One question that has been raised more than once at the conference has been the issue of relatively high bid/offer spreads quoted on European exchanges for ETFs; particularly in retail dealing sizes, and of low secondary market trading activity on the exchanges. We've also heard from the product providers that secondary market liquidity is much better than screen quotes might suggest. Do you think that there is a problem here and, if so, what can be done about increasing the visibility of the underlying trading?

Fuhr: The underlying trading isn't really the issue, as ETFs are as liquid as the basket of shares that they hold. It really comes down to trading with brokers that are able to do the creation/redemption process. In Europe, a lot of the trading activity does not have to be reported to the exchange. So the on-screen liquidity that you see may only reflect 50% or so of the real activity. There is a challenge in that market-makers may quote a tight bid/offer spread for an institution, but not for a small retail investor. The spreads that are shown on-screen are dictated by the exchanges which will typically set requirements that market-makers keep bids and offers within a certain percentage range for a minimum period of time. As far as infrequent trading activity is concerned, some of the European exchanges will capture a closing mid-price for ETFs that don't trade, and others will not. This [latter] policy can make price movements appear very strange when a fund hasn't traded for two weeks, for example. Having all the exchanges consistently publish closing prices would be helpful for everyone.

IU: Does liquidity vary according to whether the listing is primary or secondary?

Fuhr: Again, the quoted liquidity will depend on the individual exchange's reporting requirements, but at the underlying level it shouldn't vary. You will find that investors move from one exchange listing of an ETF to another for different reasons. To give an example, if one wanted to buy the S&P 500 in U.S. dollars rather than euros, it might be necessary to find another listing of the same ETF. For a European retail investor, the choice is more limited-it's usually just the local exchange in the country concerned.

So generally speaking, ETF liquidity should be no different when traded via the primary listing or via one of the cross-listings. The issue of secondary market liquidity is typically more important for someone who hasn't used ETFs before-they feel more comfortable when they see things trade on-exchange and in some volume. Once people start using ETFs and understand them, they become a bit more indifferent to the reported trading volume. Having said that, there is no doubt that in the U.S., for example, seeing billions of dollars of trades every day in certain ETFs has helped attract more retail investors.

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