Do You Know The REAL Liquidity Story Behind Exchange Traded Funds (ETF’s)?

By October 18, 2016Articles

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One of the questions we often hear from investors is – “Are ETF’s liquid enough to buy even if there is no volume trading?” 

Despite ETFs raising $100 Billion across Canada and $2 Trillion worldwide, many investors mistake ETF volume for liquidity (liquidity is the ability to get in and out of the shares without having an impact on the price). 

When, in fact, with ETFs, VOLUME ≠ LIQUIDITY.  Let us explain. 

An Exchange Traded Fund is a holding vehicle for individual securities, much like a mutual fund.  Buying or selling the ETF can be an efficient way to get access to several securities at once.  Whatever liquidity is in the underlying securities gives the ETF its liquidity.  Similar to individual stocks and bonds, there is a spread between the bid price and the ask price of ETFs but with increased demand for ETFs over the years, the spread on the ETFs has tightened dramatically.  The Net Asset Value (NAV) is the weighted average price of all the underlying securities and is updated by an auto trader every 15 seconds (as opposed to just once per day with Mutual Funds) and therefore the price of the ETF is a real-time price reflection of the underlying holdings and what they are doing on an intra-daily basis.  So, while the ETF’s trading volume may be low, the liquidity may be high because the underlying holdings’ liquidity determines the ETF’s liquidity.

We actively use both ETFs and individual securities in our Wealth Catalyst Investment ProcessTM in the Smart Risk investing approach to deliver value efficiently in our client portfolios. 

Here are some of our top tips for trading ETFs:

  1. Look at the bid and ask prices – ETFs with less liquid, foreign, or smaller cap holdings typically will justify a wider spread between the bid and ask than an ETF with more liquid, larger cap domestic holdings.
  2. Do not trade an ETF in the first 10 minutes of the market open or the last 10 minutes before the market close – the market makers need to create the ETF baskets and price all the underlying securities based on market conditions.  If markets are volatile, they will widen the spreads to give themselves a cushion so they don’t have to overpay for securities. Thus, you are likely going to pay a higher spread near the open and near the close, something to be aware of.
  3. Use limit orders, not market orders – this is a good habit to get into, if you are not in a hurry to buy or sell, in order to get the price you want.  While most market makers show a certain number of shares available at a certain price, there is often a lot more shares available behind that, and that is why a limit order at the bid or ask can help ensure a good execution price.  If you do use a limit price, however, you may miss the opportunity to buy or sell if the underlying value of the basket moves away from you, so it must be actively monitored to stay on top with the ever-changing market.  

To further make sense of it all, the Smart Risk team is hosting a panel of three industry masterminds on November 2, 2016 from 5pm – 7pm who will offer a wealth of knowledge, insight and strategies in alignment with the Smart Risk principles on how to invest amidst the market uncertainty.  This expert panel will challenge the status quo, and provide guests with resourceful strategies amidst the market volatility.  

This exclusive Vancouver event: Volatility is Back – How to Navigate the Fear and Uncertainty using a Smart Risk Approach features a panel of three experts, moderated by bestselling author and finance expert Maili Wong, who will provide insight and action item on:

 

  • How to come out ahead of the US Elections
  • The Art and Science of investing in volatile markets
  • Disruption and Innovation in the ETF industry

 

Although space is limited, we have reserved a select number of seats for friends like you who might be new to the Smart Risk Approach.

Click here to apply for a complimentary seat to the event.

Please note that applying does not mean a seat is guaranteed. Apply here today.

About Maili Wong

Maili Wong is an author, a leading Canadian investment advisor and licensed portfolio manager whose fresh, modern approach to investing for her high-net-worth clients sets her apart from others in her field. Her first book Smart Risk shares per personal story of resilience as well as lessons learned and secrets gleaned in her 15 years of international investing experience.

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