Why ETF Liquidity is More than Just Trading Volume
February 26th, 2013 at 11:20am by Arrow Funds
Plugging ETFs into a portfolio serves as an instant solution for investors and advisors’ recommendations alike. They are critical portfolio components, and their effectiveness is seldomly refuted.
ETFs are effective building blocks to strategic and tactical asset allocations, as their growth illustrates. Fitting the pieces becomes a task of research and recommendations.
Applying ETFs as solutions intraday is met with skepticism. Many practitioners borrow rules and measures for equities and from other corners of the securities industry to apply to the score the efficiencies of an ETF. One specific area of contention is efficiency of trades. [ETF Liquidity Primer]
This is at the entry point, where initial or subsequent investments are made, of an ETF. Borrowing trading traits, such as average the daily trading volume, to measure the expected capacity of an ETF to absorb new investments is an obvious objection. However, these measures do not score the capability and efficiency of an ETF at the entry point, and are not the only absolute litmus test for the viability of an ETF as an investment.
Traditional measures for investment entry points are illustrated to prove that the volume objection in choosing an ETF can be just a red herring, and not an accurate objection. The ETF in question is the Arrow Dow Jones Global Yield ETF (NYSEArca: GYLD). [Thin ETF Trading Volume Doesn't Mean Low Liquidity]
On Feb.7, a client wanted to place a trade with their custodian for 259,500 shares of GYLD. Up to this point, the 10-day average volume was 29,735—significantly less than the size of the order. The custodian called a few registered Authorized Participants of the ETF. They also called Knight Capital, which is the designated primary market maker in GYLD. A few minutes passed and Knight filled the order for the client and confirmed the trade.
What is impactful about this transaction is the efficiency of the process—that Knight’s market making ability allowed them to commit the capital required to fill the client’s trade request, all in less than ten minutes. Furthermore, the client’s trade was accommodated with no price impact. As can be seen in the daily trading activity, the price efficiency of the large sum investment is in-line with the price range of the underlying ETF.
This is proof positive that the myth about ETF volume is just a myth. When the custodian, and market participants knows how to handle a trade, the efficiencies of the market kick into gear and enable orders to be filled, and the shareholder is rewarded with this efficiency.
Arrow Dow Jones Global Yield ETF
Ray Amani is director of product development at Arrow Investment Advisors. Joe Cunningham is director of capital markets at Arrow.