Portfolio managers’ trading desks execute trades as directed by portfolio managers. They work with liquidity providers of underlying etf market makers securities to source liquidity, minimize trading costs, and seek best execution. Most providers have capital markets desks whose role is to work with portfolio managers, APs, market makers and stock exchanges to help assess true ETF liquidity and assist investors with efficient trade execution.

Comparison between ETFs liquidity and mutual fund liquidity

By appreciating the components and factors that affect liquidity, you can manage your investments more efficiently and reduce trading costs. With this knowledge, you’ll be better equipped to navigate the Stockbroker complexities of the ETF market and optimize your investment strategy. Yes, some ETFs can be illiquid if they have low trading volumes and hold illiquid underlying assets. ETF liquidity is a very important consideration for investors as it impacts financial return.

Example of Creation and Redemption Affecting Liquidity

The concept of https://www.xcritical.com/ liquidity in ETFs extends beyond the traditional understanding applied to individual stocks. It is a multitiered framework involving both the dealer and secondary markets. In the primary or dealer market, liquidity is facilitated through the creation and redemption mechanisms.

Don’t use trading volumes or fund size as a guide.

This refers to the ease with which you can trade ETF shares on an exchange. Secondary market liquidity is usually measured by trading volume, bid-ask spreads, and market depth. Let’s look at a hypothetical example of a trader looking to invest $50 million into the Mackenzie Global Infrastructure Index ETF (QINF).

Example of Liquidity Differences With Similar Underlying Assets

The daily volume traded of an ETF is often incorrectly used as a reference point for liquidity. An ETF’s liquidity is determined by the liquidity of the underlying securities whereas trading volume is influenced by the activity of investors. If an ETF invests in securities that have limited supply or are difficult to trade, this may impact the market makers’ ability to create or redeem units of the ETF which may then affect the portfolio’s liquidity. However, most Canadian-listed ETFs predominantly invest in liquid securities that trade on major exchanges around the world. Secondary market liquidity is the ease with which investors can buy or sell ETF shares on exchanges, much like individual stocks.

An ETF is also much more tax efficient for the average investor due to their in-kind creation and redemption mechanism. ETFs are therefore a good way to invest, whether it is to diversify one’s portfolio or to gain exposure to a wide range of markets, asset classes and strategies. Unlike ETFs, which are traded on exchanges like stocks, mutual fund shares are bought and sold directly with the fund at the day’s closing NAV. The real-time trading feature of ETFs provides intraday liquidity, allowing investors to execute trades throughout the trading day. Alternatively, mutual funds offer end-of-day liquidity, with all orders processed at the closing NAV.

Digital assets represent a new and rapidly evolving industry, and the value of the Shares depends on their acceptance. A disruption of the internet or a digital asset network would affect the ability to transfer digital assets and, consequently, would impact their value. Index ETFs seek to replicate the performance of an underlying index, like the S&P 500. Many ETFs seek to track an index — also known as index or “passive” funds — wherein the ETF manager typically makes less buy and sell trades of underlying assets than an active fund manager does. This low turnover means fewer sales of stocks that have risen in price, resulting in the generation of less realized capital gains. While ETFs disclose holdings daily, that typically happens monthly or quarterly with mutual funds.

• Short sellers provide liquidity, as they tend to be selling into demand when share prices appreciate, and conversely looking to buy back shares when prices decline.
• In fact, this $50 million trade would at most only constitute 2.39% of the ADV of any of the underlying stocks.
• Frequent trading of ETFs could significantly increase commissions and other costs such that they may offset any savings from low fees or costs.
• Index ETFs seek to replicate the performance of an underlying index, like the S&P 500.
• For investors working with a financial advisor, talk with your advisor about how ETFs may help you seek to achieve your financial goals.
• Because ETFs are traded on stock exchanges, they are easily bought or sold.

There can be no assurance that a liquid market will be maintained for ETF shares. Important Risk Information There can be no assurance that a liquid market will be maintained for ETF shares. These desks actively transact in the underlying ETF to dynamically hedge their position(s), as they facilitate transactions on a variety of financial instruments for institutional clients. Additionally, ETFs seeking to track indices linked to other structures, such as swaps and futures, are often used in relative value arbitrage between vehicles. As you can see, the ETF liquidity ecosystem has many participants. Let’s break down Figure 1 to understand the key ETF trading activities point by point.

They’re low cost — which can help you invest more of your hard-earned money. Like a playlist is a group of songs, an ETF is a diversified group of stocks that often seeks to track an index, like the S&P 500. When you want to listen to songs from a certain era or genre, it takes time and effort to research artists, pick individuals songs, buy those songs, and put it all together. One of the biggest misconceptions with ETFs is the notion that you can generalise their liquidity based on their structure. Liquidity has become a key focus for regulators and fund issuers alike.

To effectively access available ETF liquidity, contact your platform or brokerage trading desk or the ETF capital markets desk. For less liquid securities, such as emerging market equities, market makers may not be able to source the securities. In this case, the ETF issuer might accept cash-in-lieu as part of the ETF basket, purchase those securities directly from underlying security markets for the fund, and then charge related costs to the market maker. On a high level, liquidity in the primary market is tied to the value of the ETFs’ underlying securities, whereas in secondary market it’s related to the value of the ETF shares traded. This process ensures that the price of the ETFs stay as close to NAV as possible.

Forward-looking information is inherently subject to, among other things, risks, uncertainties and assumptions that could cause actual results to differ materially from those expressed herein. Please consider these and other factors carefully and not place undue reliance on forward-looking information. The forward-looking information contained herein is current only as of October 18, 2022.

One day, a breakthrough invention in solar energy creates waves of excitement in the market. Investors move to buy shares of GreenTech ETF to capitalize on this trend. The sudden surge in demand could drive the share price of the ETF sky-high, deviating from the actual value of the underlying assets or its NAV. The “secondary market” liquidity seen on exchanges is important for ETF investors and traders.

Therefore, all it exhibits is investor demand in that particular ETF, not its level of liquidity. Therefore, ETF liquidity needs to be looked at differently to traditional stocks or shares liquidity. Market depth refers to the volume of buy and sell orders at various price levels. Greater market depth means the market can absorb larger transactions without a significant impact on price. David has had a keen interest in financial markets since he moved with his family to Hong Kong at the age of 13. He was there during the financial crisis of 2008 and experienced it from a global viewpoint.

But one of the most important ETF features—their liquidity—is also one of the most widely misunderstood. In essence, the liquidity of the underlying holdings of an ETF directly impacts the ETF’s liquidity. A well-structured ETF with liquid underlying assets can better adapt to market demand changes, preserving fair prices and an efficient investor trading experience.