Investors should not judge an exchange traded fund’s overall liquidity based on per-conceived notions of liquidity taken from the broader equities markets.
When evaluating the liquidity for an ETF, investors should consider the perceived liquidity and the so-called hidden liquidity, instead of using traditional notions of liquidity taken from trading company stocks, according to alletf.
Traditionally, it is common practice to utilize a combination of the average daily volume and the bid-ask spread to determine liquidity for a stock. However, a number of thinly traded ETFs are based on very liquid markets. Consequently, traders can execute large trades without distorting the ETF price. [ETF Liquidity, Trading and Market Making]
Moreover, volume does not reflect movements in a fund’s underlying market. For example, fixed-income ETFs may trade on days the bond markets are closed. International stock ETFs may trade on the U.S. stock exchange when the overseas markets are closed.
Many ETF investors may find that ETFs are truly only as liquid as their underlying holdings. ETFs that track U.S. stock are among the most liquid, whereas ETFs that track emerging markets where capital markets are not as developed will also be less liquid.
For instance, the Guggenheim Russell Top 50 Mega Cap ETF (NYSEArca: XLG), which has $526.4 million in assets under management and trades with an average daily volume of about 19,500 shares, may not seem very liquid to a seasoned stock trader. However, one is only accounting for the perceived overall liquidity of the ETF.
The hidden liquidity, or true liquidity, of an ETF is in its holdings. Specifically, among XLG’s top holdings, Apple (NasdaqGS: AAPL) has a daily average volume of 58.3 million shares per day, Exxon Mobil Corp (NYSE: XOM) shows an average 9.2 million shares per day and Microsoft (NasdaqGS: MSFT) has an average 28.6 million shares per day. The top ten holdings have an average market-cap of $160 billion, and total holdings account for a market-cap of over $8 trillion.
Consequently, for those who are interested in executing large block trades, the brokerage desk can readily provide a “quote in size” for trades in more thinly traded ETFs with exposure to a deep market. The quote will generally hover around the “iNAV” as long as the underlying market is accessible. [The Underlying Value of an ETF’s Portfolio]
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Mr. Lydon serves as an independent trustee of certain mutual funds and ETFs that are managed by Guggenheim Investments; however, any opinions or forecasts expressed herein are solely those of Mr. Lydon and not those of Guggenheim Funds, Guggenheim Investments, Guggenheim Specialized Products, LLC or any of their affiliates. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.