Myth: ETFs With Low Daily Trading Volume Aren’t Liquid.
Fact: An ETF’s liquidity is determined by the liquidity of its underlying basket of securities.
Unlike a common stock, an ETF’s liquidity is not determined by its average daily trading volume. Instead, an ETF’s liquidity is primarily determined by the tradability of its underlying basket of securities. In many cases, this allows an ETF to trade in amounts exponential to its average daily trading volume.
ETF liquidity providers, commonly referred to as market makers, can create and redeem shares directly with an ETF issuer to meet demand from investors. They do this by interacting with the underlying basket of securities held by the ETF. Consequently, price changes of an ETF are generally based on the price and availability of the underlying portfolio rather than the average daily volume of the ETF itself. For this reason, a large-cap equity ETF may be more liquid than a small-cap or more narrowly focused ETF.
Myth: ETFs Have High Spreads.
Fact: ETF spreads reflect the cost of acquiring the portfolio.
Spreads in ETFs often reflect the underlying liquidity of the securities they track. For ETFs that focus on highly liquid assets, such as large-cap equities, spreads are typically very narrow. Conversely, ETFs that track less liquid markets, such as emerging markets or niche sectors, may have wider spreads, but this mirrors the costs and risks of trading the underlying securities. Generally, investors should be prepared to pay the offer price when buying an ETF and accept the bid price when selling it.
Myth: The Last Price for an ETF Reflects Its Current Value.
Fact: The last price of an ETF is just that – the last price.
The price an investor pays for an ETF is determined by the value of its underlying securities at the point of sale. If an ETF doesn’t trade frequently, the value of the portfolio may have substantial movement between executed trades. In that scenario, using the last price could be an irrelevant benchmark of the ETF’s fair value. The real-time value of an ETF is the price at which an investor can buy or sell, which is reflected in the ETF’s bid/ask spread.
Myth: Active ETFs Are Difficult and More Expensive to Trade.
Fact: Active ETFs are as easily traded as passive ETFs.
Active ETFs leverage the same ecosystem of institutional liquidity providers as passive ETFs. These liquidity providers utilize powerful technology to enhance price discovery and tradability in both active and passive ETFs. In most cases, executing an ETF trade should be a quick and efficient experience.
