Advantages of a market maker

Claymore Investments, Inc. 14 May, 2010 | 2:46AM

Lower expenses are available to ETF investors because ETFs track indexes and therefore do not have to pay the high cost associated with active portfolio management. Lower turnover within the ETF also results in fewer transaction costs, which again keep the costs of the ETFs low. The market makers allow for further savings because they buy in bulk the underlying basket of securities and generally cover all trading and transaction costs within the ETF.

Tax efficiency is enhanced with an ETF as the transactions between the DB and the ETF itself represent an exchange of securities known as an "in kind" transaction. So while redemptions in traditional mutual funds may cause trading and realized taxable events, ETF investors are less affected by the actions of other investors, further enhancing the tax efficiency that ETFs offer relative to mutual funds.

The liquidity of ETFs is often overlooked by investors as one of the advantages of ETFs. In fact, one of the most common misperceptions about ETFs is their liquidity. Many investors familiar with trading individual stocks will look at the trading volume of an ETF as an indication of its liquidity. But with ETFs, volume does not equal liquidity. The liquidity of an ETF is derived rather from the liquidity of the underlying basket of securities and in fact has two layers of liquidity: First the individual market participants, or the supply and demand of the market, and second, the designated brokers.

These bid and ask prices that the designated broker posts provide a narrow spread in which all trading can occur, keeping the trading price of the ETF close to the actual net asset value of the underlying basket, and providing investors the comfort of knowing they can always buy or sell an ETF at any time the markets are open.

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Claymore Investments, Inc.

Claymore Investments, Inc.