The ETF universe is quickly expanding with new and innovative strategies, but they aren’t always met with widespread acceptance. Investors interested in new or interesting ETFs should not immediately dismiss them solely based on the lower trading activity or volumes.
“When it comes to reading and interpreting an ETF’s true liquidity, it’s vital that investors look below the surface. So while some pundits suggest that new ETFs always carry elevated risks based solely on their lower average daily trading volume, that’s simply not true. There can be newly issued ETFs with deep liquidity, much of it unseen on a trading screen,” according to a new insights paper by VictoryShares ETFs.
Specifically, ETF investors should understand that average daily volume is not a definitive representation of an ETF’s liquidity.
Graphic courtesy VictoryShares
ETFs are an investment tool that tries to reflect the performance of a benchmark index. Consequently, an ETF’s true liquidity is more related tot he liquidity of the underlying basket of securities. If an ETF exhibits low average volume, it does not mean that it is difficult to trade.
Due to its innate creation and redemption process, ETFs are able to create and redeem shares based on supply and demand through the help of Authorized Participants whom work with ETF issuers and market participants to help provide more efficient or seamless ETF trades.
Related – VictoryShares: Not All ETFs with “Volatility” in the Name are Equal
Nevertheless, there are still some important points to consider when executing a trade. For instance, if an investor uses a trading desk for large trades, they may receive more efficient pricing because the trading desks have access to more avenues for liquidity, including trading that occurs over-the-counter.
“Thus, the perception that it’s too risky to buy newly issued ETF may be naive. Of course due diligence is required for any ETF to understand who stands behind the investment and whether the sponsor has the experience and relationships to provide adequate liquidity,” VictoryShares added.
Investor should also keep in mind other best practices for ETF trades such as when to execute orders. ETF spreads tend to be wider during the opening of the exchange, and under normal market conditions, ETF spreads will typically tighten after the first 30 minutes of trading. Additionally, investors should keep market orders for smaller traders because they only access on-screen liquidity and stick to limit orders to better control larger trades.
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