Typically only one-tenth of the volume of an iceberg is above water, with the rest beneath the surface. This makes the full extent of the entire mass difficult to appreciate by just looking at the tip of the iceberg. ETF liquidity can be viewed similarly.

Measuring an ETF’s liquidity isn’t as simple as checking the average daily trading volume and bid/ask spread in the secondary market. Looking only at this ‘onscreen liquidity’ misses some of the most important benefits of the ETF structure—the ability to create and redeem shares by tapping into the primary market liquidity of the securities within the ETF.

And when you’re not looking deeper than the tip of the ETF liquidity iceberg, you’re not taking into account all avenues of liquidity in your ETF selection process.

For illustrative purposes only.

Primary market liquidity through ETF creation and redemption

The liquidity of an ETF’s underlying securities can enhance the liquidity of the ETF. This is all made possible by authorized participants (APs) and their role in ETFs’ unique creation and redemption process.

APs are US-registered, self-clearing broker dealers who create and redeem ETF fund shares, thereby helping to keep the balance between supply and demand of ETF shares in the secondary market. While stocks only have a finite number of shares available in the marketplace, APs can create ETF shares or redeem them for securities in response to changes in market demand.

This ability to introduce additional shares into the marketplace on a daily basis demonstrates that the quoted ETF trading volume is not the sole measure of the fund’s overall liquidity.

Beyond onscreen ETF liquidity: A real-life example

The concept of deeper levels of ETF liquidity is perhaps best illustrated by a real-life example. On March 14th 2018, an investor looked to buy 190,575 shares of the SPDR® MSCI Emerging Markets StrategicFactorsSM ETF [QEMM]1—a large enough purchase to be almost 9 times the prior 30-Day average daily volume.2

Around that time, the fund was being offered on screen at $66.99 in the secondary market. The investor reached out to their block desk—which specializes in facilitating large “block” trades arranged at defined prices—and agreed on an execution price of $66.81, which was 18 cents better than the ask price available on exchange.

In the end, the investor was able to execute the order at one price on a single day. Such trading efficiencies wouldn’t have been possible if the investor hadn’t leveraged the techniques of the block trading desk as well as the ability of APs to tap into the ETF’s underlying liquidity.

For investors, it’s important to utilize the full range of resources available—most notably execution desks, liquidity providers, and subject matter experts like our SPDR Capital Markets Group here at State Street Global Advisors. In addition, please do not to shy away from ETFs with small AUM or lower trading volume if you believe the product can provide a unique strategy to satisfy your investment needs.

1Prior to July 15, 2016, the SPDR MSCI StrategicFactorsSM ETF suite was known as the SPDR MSCI Quality Mix ETF suite. There were no changes to the investment objectives, strategies or policies of any of the funds comprising such suite in connection with each fund’s name change.
2Bloomberg Finance L.P., as of 3/14/2018.

Definitions

Block trade
A block trade, also known as a block order, is an order or trade submitted for the sale or purchase of a large quantity of securities. A block trade involves a significantly large number of equities or bonds being traded at an arranged price between two parties, sometimes outside of the open markets, to lessen the impact on the security price.

Liquidity
The ability to quickly buy or sell an investment in the market without impacting its price. Trading volume is a primary determinant of liquidity.