David Wysocki: Hi, my name is Dave Wysocki, Vice President of Sales at Harvest ETFs. I’m going to show you why ETF liquidity is different from stock liquidity. Because ETFs trade on an exchange just like individual securities do, many investors believe that trading volume on a security and trading volume on an ETF is one and the same. That is simply not the case. An ETF has two components to its liquidity, primary and secondary liquidity. The primary liquidity involves the underlying securities, which make up the ETF. While secondary is simply the trading volume on the exchange. An ETF might have low trading volume but yet be highly liquid due to the nature of the securities it owns. An ETF insurer, for example, Harvest will work with market makers to purchase and redeem liquid securities. This creates or redeems units of an ETF.
Because we focus on large cap companies that are highly liquid, our ETFs tend to have natural liquidity. However, if an ETF holds illiquid stocks or ones that trade on a different exchange, that ETF may be subjected to a wider bid-ask spread. The role of a market maker is to ensure that investors in Canadian ETFs have it on that particular ETF. However, the bid-ask spread is determined by the underlying liquidity of the stock. Secondary liquidity, as I alluded to earlier, is simply the trading volume that exists on that ETF in the market. It is determined by the supply and demand of that ETF. Therefore, when you look at the liquidity of an ETF, investors should look not only at the trading volume, which is the secondary market, but also the basket, which makes up the ETF in order to ensure largest liquidity and tie the spread.
For more news, information, and strategy, visit the Financial Literacy Channel.