Consequently, along with the daily trading volume and bid-ask spreads that investors would see on their brokerage account, people need to also monitor the liquidity of the underlying securities, which may arguably be more important for ETFs.
“It is the liquidity of the underlying securities that tends to be a more important factor for determining ETFs’ true liquidity, since that is what determines how easily an authorized participant could go to the capital markets to buy or sell those securities in order to create or redeem new shares in an ETF,” Gabriel added.
If the underlying market is illiquid, authorized participants will have a harder time efficiently creating or redeeming ETF shares, which can lead to greater spreads in the secondary market. This is also the major concern that many fixed-income observers are voicing as the popularity of bond ETFs grows and the underlying debt securities remain less liquid ahead of an interest rate hike. [Liquidity Concerns in Corporate Bond ETFs]
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.