The True Liquidity of an ETF BMO Global Asset Management

Essentially, ETFs have different levels of liquidity based on the securities it holds, the trading volume of those securities, the trading volume of the ETF and the trading environment. In addition to possible tax benefits, the creation and redemption of shares via in-kind transactions helps ensure that the value of an ETF’s shares generally moves in connection with the value of its underlying https://www.xcritical.com/ holdings. Thus, liquid funds can empower your idle funds to generate slightly higher returns compared to bank savings accounts while ensuring almost comparable liquidity and relative stability. Investments can be made through a distributor or directly via various financial portals and apps.

Understanding the ETF Liquidity Ecosystem

• For example, 80% of investment grade bond ETFs traded at all-time high discounts to NAV, according to Citi analysis.
• For a summary of the risks of an investment in BMO Mutual Funds, please see the specific risks set out in the prospectus.
• Passive management and the creation/redemption process can help minimize capital gains distributions.
• Investors wonder – if they buy the instruments, will they be able to sell them again?
• ETFs rely on a unique creation and redemption mechanism that provides primary market liquidity.

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A simple approximation of intraday spreads using daily data

The size of an ETF measured by its assets under management (AUM) likewise doesn’t necessarily dictate its liquidity. Even ETFs with smaller AUM can have high liquidity if they track a liquid index or sector and have active APs facilitating the creation and redemption process. An investor who buys shares in a pool of different individual stocks has more flexibility than one who buys the same group of stocks in an ETF.

Freedom of choice impact on country-specific liquidity commonality

But the key point is that both primary market and secondary market liquidity play a role in providing a full picture of ETF liquidity. In essence, the liquidity of the underlying holdings of an ETF directly impacts the ETF’s liquidity. A well-structured ETF with liquid underlying assets can better adapt to market demand changes, preserving fair prices and an efficient investor trading experience. 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.

Fixed income ETFs: Primary market participation and resilience of liquidity during periods of stress

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Dispelling the myths surrounding liquidity and ETFs

These funds aim to increase returns and mitigate price risk by investing in a diversified portfolio consisting of call money, short-term securities, and money market instruments with short maturities. We start with a discussion of the primary and secondary markets for ETFs, including the creation/redemption process, before moving on to important investor considerations, such as costs and risks. We then explain how ETFs are use in strategic, tactical, and portfolio efficiency applications. Second, our paper enriches the literature on ETFs by investigating the magnitude and direction of the liquidity spillover between ETFs and their constituents. While this spillover is expected between an ETF and its underlying portfolio, its intensity and direction are unknown in the literature.

Using high, low, open, and closing prices to estimate the effects of cash settlement on future prices

Liquidity is one of the most important features of exchange-traded funds (ETFs), though frequently misunderstood. An ETF’s liquidity refers to how easily shares can be bought and sold without impacting the ETF’s market price. An ETF’s liquidity is crucial because it impacts trading costs and helps determine how closely the ETF’s price tracks its underlying assets. Our paper investigates market-level determinants of the liquidity spillover between the ETF and its underlying portfolio. Liquidity spillover shares similar market-level determinants to liquidity commonality. These findings are consistent with the “wealth effect” theory of financial contagion of Kyle and Xiong (2002), which argues that increased risk aversion in the marketplace intensifies liquidity spillover among asset classes.

Journal of Finance and Data Science

All persons and entities accessing the Site do so on their own initiative and are responsible for compliance with applicable local laws and regulations. The Site is not directed to any person in any jurisdiction where the publication or availability of the Site is prohibited, by reason of that person’s nationality, residence or otherwise. From Sectors and Smart Beta to Fixed Income, SPDR Exchange Traded Funds (ETFs) give you wide access to diverse investment opportunities. Tracking error measures how closely an index ETF tracks its benchmark index. In the case of international or global ETFs, the fundamentals of the country that the ETF is following are important, as is the creditworthiness of the currency in that country.

Bid, ask and transaction prices in a specialist market with heterogeneously informed traders

The only constraint to liquidity is the liquidity of the underlying index.”Volumes of ETFs trading are, Dubois says, a little low. The market makers who operate in the US do not do so to the same extent in Europe. The weak volumes are more perception than reality, though, he says, but SSGA aims to overcome it. “We hope to find ways to increase volumes,” he says.While liquidity may not be a problem, some are concerned by the differences between the ETF price and the net asset value of the underlying. “Investors might be getting a good deal compared to actively managed alternatives, but whether they are against other passive investments is open to question,” he says.

We also investigate factors that may affect the gap between ETF and underlying liquidity. First, when an ETF is traded on the market, it has its own trading volume, return volatility, market capitalization, and market price. These trading characteristics reflect both inventory costs and the information asymmetry of the traded security (Stoll, 2000; Van Ness et al., 2001). In particular, we look at discrepancies in market capitalization and trading volume between an ETF and its underlying stocks. ETF liquidity is based on the dynamics in the dealer and secondary markets. Dealers acting as APs can create and redeem ETF shares to meet supply and demand changes in the ETF and keep its market price in line with its NAV.

The specialist can access additional data on the depth of liquidity and suggest a trading execution strategy. So your “on screen” view may display an ETF’s trading volume on the London Stock Exchange but not show its volume on other exchanges such as Euronext or the SIX Swiss Exchange. ETF trading desks help ensure that large ETF trades are executed efficiently. They are able to find liquidity in an ETF regardless of its average daily volume or the liquidity shown on the trading screen.

The views and opinions in this communication do not necessarily state or reflect those of BMO Global Asset Management. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. A stock which is thinly traded will be much less liquid than a large cap, blue chip stock.

Financial professionals should work with their clients to ensure they are aware and comfortable with the levels of risk being taken. An ETF is made up of several diversified “building blocks” such as stocks, bonds or commodities. An individual block can represent a company (Apple) or country (Mexico), but together they form an industry (technology) or a continent (Latin America). Neither party should be liable to the other for any loss or damage which may be suffered by the other party due to any cause beyond the first party’s reasonable control including without limitation any power failure.