Investors who are interested in investing with ETFs should consider an approach to achieve the best possible execution and an overall positive trading experience.
For example, many investors tend to look at a security’s liquidity to determine whether or not they will be able to execute an efficient trade. On the recent webcast (available On Demand for CE Credit), Mechanics of ETF Trading and Liquidity, Matt Lewis, Vice President and Head of ETF Implementation and Capital Markets, at American Century Investments, explained that to understand ETF liquidity, investors should consider the secondary market where ETFs trade, along with the ETF market depth and primary markets.
ETFs trade like a stock on an exchange with a bid-ask spread and exhibit an averaged daily volume. However, this is not the true indicator of an ETF’s overall liquidity. An ETF’s true liquidity is better determined through the creation and redemption mechanism through the help of a market maker.
Investors may also immediately focus an ETF’s spread or difference between the bid-ask to determine tradability. Lewis explained that spread is affected by a number of factors, including underlying securities, type of underlying securities, volume, day-to-day news events, creation costs and market volatility.
Since ETFs track a basket of underlying assets, investors may get a better sense of what they are paying for by comparing the ETF’s price to its net asset value, or NAV. Investors may also note that the ETF’s price may exhibit a premium or discount to its NAV.
To understand market depth, ETF traders may notice market makers post quotes that define the number of shares available at the market bid and ask. Additional shares may also be available through ETF block desks or by placing a limit order a few pennies below the bid or above the offer, Lewis added.