here on the blog is to report on ETF inflows and outflows, which
is a great way to help investors identify emerging trends.
Something that always strikes me is that if you
read my blog posts, you might get the impression that the
categories I'm discussing (for example, broad US equity or high
yield bonds) are the only ETFs seeing any trading action.
But with ETFs making up more than 25% of equity market trading
volume most months, this simply isn't the case.
The truth is, even funds that don't have net inflows and
outflows - or
activity - can still experience considerable
trading volume. What's more, the fact that they do is a
great illustration of one of the most
salient benefits of ETFs
For many ETFs, significant two-way (buy and sell) activity
generally means that investors can trade the fund back and forth
without there being a need for
creations and redemptions
. The iShares Emerging Markets ETF (
) is a great example of this phenomenon. Because some of
tend to be thinly traded and hard to access, EEM has become a
preferred vehicle for trading these emerging markets
stocks. As a result, it has grown very large (~$39 billion
as of 9/11/13) and typically sees a lot of secondary market
For example, between August 6
(six consecutive trading days), EEM had no net inflows or
outflows. Meanwhile, the fund's average daily volume (ADV)
during that time was $2.4 billion. Close to
360 million shares, or $14.2 billion
, changed hands without any need to tap into primary market
liquidity. That's a lot of two-way volume.
There are a couple of big takeaways for investors.
Generally the more trading volume a security has, the tighter its
tends to be, which lowers the trading cost for investors.
In some cases, the ETF's spread is actually tighter than the
spread of its underlying securities - this is typically the case
with some of the more liquid ETFs out there (see below).
For example, EEM's spread of 2.3 basis points compares
favorably to the average weighted bid-ask spread for its
underlying basket of stocks at 45 basis points. That cost
savings, for the same economic exposure, can be attractive to
investors transacting in the secondary market and is a compelling
feature that many ETFs offer.
Sources BlackRock and Bloomberg as of 6/17/13.
Bid-ask spread is the time-weighted intraday spread averaged
over the previous 20 days.
In addition to the benefits of secondary market liquidity,
ETFs also benefit from the primary market function. When
there's significant supply or demand pressure on an ETF, shares
can simply be redeemed or created in order to meet investor
needs. This means that an ETF's on-screen liquidity (i.e.
shares available to trade) only tells part of the story, because
(APs) can always make more.
When we say that ETFs have "two layers of liquidity" or
"hidden liquidity", this is what we're referring to: the
secondary market, which can provide easier access and tighter
spreads, and the primary market, which can meet the supply and
demand needs of investors.
Sources: BlackRock and Bloomberg
Dodd Kittsley, CFA, is the Head of Global ETP Market
Trends Research for BlackRock and a regulator contributor to
. You can find more of his posts