Investors turning to ETFs rather than mutual funds may find some hidden risks. The Wall Street Journal's Eleanor Laise reports that trading costs could create a "treacherous landscape" for ETF investors.

Those issues are the most likely to arise with smaller ETFs, or those whose shares trade less frequently. The lack of volume can increase spreads and create relatively large premiums or discounts to the ETFs NAV despite the ability of institutional investors to trade baskets against the ETF. If the fund is too small, institutions would not earn large profits arbitraging its portfolio and market makers have little incentive to keep the pricing gaps narrow.

Some of those issues are masked by the fact that the largest 10 ETFs account for 40 percent of the $791 billion of assets in the vehicles and 60 percent of December's trading volume. That amount is 47 percent more than at the end of 2009. Trading in ETFs jumped 20 percent to an average 1.9 billion shares a day in 2009, according to the National Stock Exchange.

Meanwhile, the issues may crop up in the smaller ETFs. The paper holds out the example of the Claymore U.S. Capital Markets Bond ETF which featured an average bid-ask spread of $2.56 per share in December, a month that saw just 12,000 shares change hands.

Claymore's fund was not alone. The paper adds that more than one-third of the NYSE Arca listed ETFs had spreads of more than five cents recently. That translates to 300 of the 800 listed ETFs. Six of that number had spreads of more than fifty cents.

The paper also pointed to the suspension of unit creation in the iShares S&P GSCI Commodity-Indexed Trust ETF last August and a the PowerShares DB US Dollar Index Bullish ETF in Devember as showing another potential risk. 

Stay ahead of the news ... Sign up for our email alerts now
CLICK HERE