ETF 2-for-1 Splits – Gimme’ a Break!

October 31, 2008 by  
Filed under Commentary, ETFs

Earlier this week, RevenueShares Investor Services declared a 2-for-1 stock split for three of its ETFs. At the close on Wednesday, November 5, RevenueShares Mid Cap Fund (RWK), and RevenueShares Small Cap Fund (RWJ) will issue one additional share for every outstanding share. On Thursday, the ETFs will commence trading at their new split-adjusted prices.

Why in the world would someone perform a 2-for-1 split on a security that is trading in the neighborhood of $35? According to the company’s press release, “The 2-for-1 stock split is expected to double the average daily trading volume of RevenueShares ETFs. This comes at a time of increasing interest by some investors looking for the benefits of a passively managed Exchange Traded Fund with the upside potential of weighting the S&P Indexes by revenue.”

I don’t want to knock the concept behind RevenueShares. In fact, I applaud them for bringing novel products to the market that are not just another “me too” ETF in an already over-crowded field. However, you really have to wonder about this one.

First of all, as any of you that have read my ETF Deathwatch reports know, I believe that investors and traders should focus on Average Daily Value Traded (ADVT) instead of volume. Isn’t that what is really important? How many dollars worth are being traded every day, not how many shares. As you can see, share volume can easily be misleading or manipulated. One million shares of an ETF traded with an $8 price is not the same as one million shares of an ETF at $180.

At least RevenueShares didn’t use the standard line of “it makes our shares more affordable” when making this announcement. If an investor cannot afford to buy a share at $36, then that investor should not be looking at securities priced at $18.

I don’t usually make predictions, but I’m going to make an exception today. I predict that this 2-for-1 split will not have the desired effect.

Let’s look at what this split means to a typical investor. As I write, RWK is trading at $33.34 with a bid/ask spread of 13 cents. The trading day is about half over, and RWK has registered three trades for a total volume of 1,850 shares. I don’t ever recall seeing a 2-for-1 spilt that noticeably improved the b/a spread. So after the split, I expect RWK to trade for $16.67 with a b/a spread that is likely to still be more than 10 cents. The split may therefore increase the b/a spread from 0.4% to 0.6%.

Many traders pay brokerage commissions based on the number of shares traded. Purchasing $50,000 of RWK today would require about 1500 shares (and it would be the biggest trade of the day). After the split, a $50,000 trade will require about 3000 shares. If you are paying a per-share commission, then your commission just doubled. And that is on top of the cost of the increased b/a spread.

RevenueShares are good products. It’s a shame they haven’t attracted more investor attention, assets, and trading volume. However, announcing a 2-for-1 split after the shares are already trading more than 30% below their IPO price is probably not the best solution.

Creative Commons License photo credit: markus941


One Response to “ETF 2-for-1 Splits – Gimme’ a Break!”

  1. Paul Weisbruch on July 2nd, 2009 6:07 pm

    It has been about 9 months since this article was published, and it is time to readdress this. The AUM in the RevenueShares ETFs has more than tripled to approximately $133 million now, since the publication of this article, and the number of market makers in the ETFs and Authorized Participants has grown at least fivefold. A point that was not mentioned in this article is that ETF companies have an incentive to get market makers and institutional trading desks to work with them, to insure tight spreads, and efficient markets in their ETFs that have accurate pricing in and around NAV. The notional value of an ETF is very important to a market maker when it comes to creation/redemption costs, as it is cheaper for a market maker to create or redeem a $17 ETF than a $35 ETF. Most ETFs can only be created or redeemed in 50,000 share blocks, so it’s much more appealing for the market makers to create/redeem regularly (and cheaper) on lower priced ETFs. This encourages more institutional activity, tighter spreads, more active market makers pricing the underlying index baskets and trading the ETFs accordingly, etc etc. So the 2 for 1 split back in October in 2008 has been nothing but a success, for the ETF company, the investors, and the institutional trading desks that are involved in these products.

    As for the notion of ADVT, as an ETF company, the volume isn’t so important to the issuer as is “what side” the volume is on. If 100% of your daily volume is new buyers in your ETFs, then that is good for the long term viability of the fund company. If you have a lot of volume and it is half buyers, half sellers, or worse, more sellers than buyers, that does not benefit the ETF company, and is largely just noise. Does a lot of volume lead to tight bid/ask spreads and efficient pricing? Yes it does. But average daily trading volume is only part of the overall story. Thank you.

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