Looking Inside Liquidity

Abstract

The purpose of this article is to provide context regarding the key considerations and drivers of liquidity for ETFs and to highlight their features that make sourcing liquidity unique compared to other investments. A review of spreads, market depth, and ETF structure will help investors better understand ETF liquidity and what it means in relation to total costs. When considering ETFs, it is critical to examine both the liquidity of the underlying stocks and the ETF's secondary market volume in order to evaluate overall liquidity. The liquidity of an ETF is highly dependent on the liquidity of its underlying stocks, as evidenced by the size of ETF bid ask spreads on the secondary market. However, tighter spreads than that of the underlying basket have emerged for several ETFs due to their own robust trading volume. As ETFs continue to mature, they can offer increased trading efficiency versus the index's portfolio of underlying securities. Importantly, because of their innovative creation/redemption structure, ETFs also offer investors the opportunity to trade more than their average daily volume without significant market impact