Why Do ETFs Split or Reverse Split?
ETF Splits and Reverse Split Causes
Why do ETFs Split and Reverse Split?
ETF splits are a semi-common occurrence. They don't happen every day, but they are not rare either. And they are very similar to stock splits, which makes sense because many of the characteristics of stocks hold true for ETFs as well. So, if you want to learn more about ETF Splits and Reverse splits, I have you covered:
However, now we are talking about why this may happen.
Why do ETFs Split?
In most cases, ETFs split to make the price more attractive to potential investors. If you could buy an ETF for $25 or $50, which would you choose? I know there are many factors involved – amount of outstanding shares, research, market conditions, etc – but even still, if an investor likes a particular fund, it may look more attractive at $25 than $50 and he or she can buy more shares within his budget at $25 than they can at $50.
So usually an ETF split happens when the price of the fund is pretty high, which can make the ETF a little pricey for investors.
Using the pretend fund MARK, if the shares were worth $50 each, an investor would need to spend $5,000 to own 100 shares. If each share was worth $25, the investor would only need to spend $2,500 to own 100 shares.
Also, when an ETF spits, there are more shares available to trade. The higher number of shares outstanding can result in greater liquidity for the fund, which encourages more trading activity and in some cases cause the bids and offers to tighten their spread.
And even while mathematically, an ETF split should change the total value of your investment, it can result in renewed investor interest, which can drive up the fund price.
This impact is usually temporary, but it does psychologically help the average investor invest in more of shares in some funds by making the price more attractive.
Why Do Reverse Splits Happen?
Typically when the price of an ETF gets too low, the provider may announce a reverse split to bring the price back up to a more “tradable” level. Or the fund may reverse split to make it look more valuable in an investor’s eyes or even avoid going too low and getting delisted. Some ETFs actually have price levels that trigger a reverse split for these very reasons.
In other cases, a reverse split happens to fulfill stock exchange minimum price listing requirements. Some stock exchanges generally specify a minimum bid price for an ETF to be listed. If the fund falls below this bid price, it risks being delisted altogether.
A third reason that a fund may reverse split is that by reducing the outstanding shares, the ETF becomes harder to borrow, making it difficult for short sellers to short the fund.
And as we said above, when an ETF splits, the bids and offer quotes may tighten. But in the case of a reverse split, the opposite comes true. The limited liquidity can widen the market spread, which then deters trading and short selling of the fund.
The good news is that ETF and stock splits are always announced ahead of time, which gives the investor a chance to prepare or adjust their trading strategies if need be. And after a split, all traders should make sure their accounts settle correctly and they have the new and correct amount of shares in their portfolios. Banks and Clearing Firms can make mistakes, no one is perfect.
So there are some of the reasons a fund may split or reverse split, but not the only reasons. And now you have a better understanding of how this all works. And as always, good luck with all of your trades.