Why ETF liquidity matters for every investor

The real-time trading feature of ETFs provides intraday liquidity, allowing investors to execute trades throughout the trading day. Alternatively, mutual funds offer end-of-day liquidity, with all orders processed at the closing NAV. This basic difference makes the liquidity experience between ETFs and mutual funds distinct, catering to different investor preferences and strategies.

etf liquidity

When investors want to sell their GreenTech ETF shares, a fluid redemption process supported by the liquidity of the underlying holdings helps ensure that the excess supply of ETF shares is efficiently absorbed. And if the trading volume of an ETF’s core assets is significant, the ETF’s total liquidity rises. The most apparent source of liquidity for ETF is trading activity, although it is not the only one. The average daily volume of shares moved in the secondary market amongst traders adds to an ETF’s liquidity.

Who Are the Major Liquidity Players in the ETF Market?

One day, a breakthrough invention in solar energy creates waves of excitement in the market. Investors move to buy shares of GreenTech ETF to capitalize on this trend. The sudden surge in demand could drive the share price of the ETF sky-high, deviating from the actual value of the underlying assets or its NAV. We are often asked the question — how does SPY’s higher trading volume distinguish it from other S&P 500 ETFs? Secondary market trading is an essential layer of ETF liquidity (Figure 1).

The spread is the cost of doing business, and it is the difference between the price you would pay to buy an ETF and the amount you would receive if you sold it. The lower the spread, the more liquid your ETFs will be, whereas the higher the spread, the lesser liquid your ETFs will be. There can be no assurance that an active trading market for shares of an ETF will develop or be maintained. 1 Spreads and price volatility calculations are SPY-adjusted; daily SPY spread and volatility is used as a baseline to de-trend data.

ETFs and liquidity

Alternative investments involve greater risks than traditional investments and should not be deemed a complete investment program. They are not tax efficient and an investor should consult with his/her tax advisor prior to investing. Alternative investments have higher fees than traditional investments and they may also be highly leveraged and engage in speculative investment techniques, which can magnify the potential for investment loss or gain. The value of the investment may fall as well as rise and investors may get back less than they invested.

  • Because ETFs hold multiple securities in the portfolio, the spread of those securities also influences the spread of the ETF.
  • CBOE Volatility Index® (VIX®)
    A measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.
  • In this case, the ETF issuer might accept cash-in-lieu as part of the ETF basket, purchase those securities directly from underlying security markets for the fund, and then charge related costs to the market maker.
  • For illustrative purposes only and not intended to be a recommendation to take any particular investment action.
  • Leading spot bitcoin funds include BlackRock’s iShares Bitcoin Trust (IBIT) fund and Grayscale’s Grayscale Bitcoin Trust (GBTC), each of which have nearly $20 billion in assets.

Secondary Market
The market in which ETF shares or common shares of public companies that currently exist are traded on exchanges between investors. Liquidity
The ability to quickly buy or sell an investment in the market without impacting its price. They engage with portfolio managers, traders, product managers, and other stakeholders to address any liquidity issues identified. Explore insights into an evolving investment landscape and the explosive growth of exchange traded funds (ETFs). Although ETFs have many characteristics that are similar to stocks, liquidity is not one of them.


ETFs rely on arbitrage activities to keep the fund’s market price in line with its NAV. And so, when designing an index for an ETF to track, the product development team ensures the ETF basket is liquid enough to efficiently manage the fund from a liquidity perspective. This, in turn, allows market participants to effectively create/redeem ETF shares and keep International Commerce Erp prices in line with NAV. These transactions may impact the liquidity of underlying security markets. Before creating ETF shares, market makers may need to source underlying securities in the ETF basket by tapping into their own inventory or buying from the underlying security market. Consider spot bitcoin and ether ETFs, which were approved by the U.S.

etf liquidity

The liquidity concept of ETFs is multilayered because ETFs are essentially asset baskets. The higher the liquidity of the underlying asset that comprises an ETF, the easier it is to redeem the ETF itself. In April 2021, the NYSE enhanced its industry-leading ETF Liquidity Program by introducing new requirements and incentives for additional market makers (“Less Active ETF Leads”) for new and/or low-volume ETFs listed on the NYSE. After having already studied the initial market quality effect of this initiative, we reexamine the issue at the program’s 1-year anniversary during a period of surging market volatility. As a result, regulators worry that, in a selling crisis, APs may liquidate ETF units at steep discounts, or back away entirely from performing this function. “A general retreat from active public equities to illiquid investments [in the private sector] all point to a greater fragility of liquidity in public markets.

Bitcoin and Ethereum Are Not the Same

The bulk of ETF liquidity is in the primary market, where the ETF market makers can access the liquidity of the underlying securities they hold. Here, the creation and redemption mechanism, which is an important process for ETFs, comes into play. APs are the only counterparties allowed to enter creation and redemption orders with the fund. They are typically self-clearing broker-dealers that serve many functions, including acting as dealers in ETF shares in the secondary market and as agents for market makers and other liquidity providers to create/redeem ETF shares.

etf liquidity

On a high level, liquidity in the primary market is tied to the value of the ETFs’ underlying securities, whereas in secondary market it’s related to the value of the ETF shares traded. Conversely, if some or all the underlying stocks are illiquid—they are hard to buy or sell without significantly affecting the price—the APs might face challenges in assembling or disassembling the baskets quickly. This delay could affect the timeliness and efficiency of the creation and redemption process, affecting the liquidity of the GreenTech ETF.

Securities and Exchange Commission in January and May 2024, respectively. The relatively new cryptocurrency market suggests that their liquidity may not be deep enough to allow traders to move quickly into and out of positions as is possible with other ETFs. The funds presented herein have different investment objectives, costs and expenses. Each fund is managed by a different investment firm, and the performance of each fund will necessarily depend on the ability of their respective managers to select portfolio investments.

etf liquidity

Therefore, it‘s important to look beyond trading volumes and on-screen indicators when assessing ETF liquidity. Knowing more about liquidity in the primary and secondary markets may help you evaluate ETFs more strategically. The Grayscale Ethereum Trust (ETHE), which currently trades over the counter in the United States, has only about $11 billion in assets under management.

There can be no assurance that a liquid market will be maintained for ETF shares. Important Risk Information
There can be no assurance that a liquid market will be maintained for ETF shares. These desks actively transact in the underlying ETF to dynamically hedge their position(s), as they facilitate transactions on a variety of financial instruments for institutional clients. Additionally, ETFs seeking to track indices linked to other structures, such as swaps and futures, are often used in relative value arbitrage between vehicles. At the end of each trading day, the ETF issuer publishes the Portfolio Component List, which includes the security names and corresponding quantities that comprise the ETF basket for the next trading day.

It is constructed using the implied volatilities of a wide range of S&P 500 index options. Passively managed funds invest by sampling the index, holding a range of securities that, in the aggregate, approximates the full Index in terms of key risk factors and other characteristics. This may cause the fund to experience tracking errors relative to performance of the index.

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