Understanding ETF liquidity

Welcome to our ETF education video series. In this second video, we’re providing an understanding of the liquidity of ETFs. If you missed our first video on the mechanics of the ETF ecosystem, be sure to catch that on our website, ThriventETFs.com. That information will help explain the multiple layers of liquidity ETFs have.

Let’s jump right in with the biggest ETF liquidity misconception amongst investors, which is that an ETF’s trading volumes or asset levels are reliable indications of its liquidity. This misconception tends to come from investors’ understanding of how stocks trade; however, stocks trade with a generally fixed supply of shares in the market, whereas the supply of ETFs is dynamic and can be dialed up or down to meet liquidity demands in the market, as we covered in the first video.

This has important implications for the true depth of an ETF’s liquidity. There are multiple layers of liquidity to understand in order to get the full picture, and like an iceberg, much it lies beneath the surface.

The first layer is displayed liquidity. This is what’s visible on screen on the exchanges and can be analyzed through average daily trading volumes and order book depth.

The next layer is liquidity that is available but not displayed. This hidden liquidity resides in the inventories of market makers trading the ETF. Now, when demand exceeds what’s readily available in the secondary market, liquidity providers can utilize the liquidity of an ETF’s underlying holdings to create or redeem shares and efficiently satisfy demand in the market.

As an example, if there are not enough ETF shares already available in the secondary market to satisfy a particularly large purchase, liquidity providers can access the liquidity of the underlying market by buying that ETF’s underlying securities and exchanging them in a creation unit for the additional ETF shares necessary to fill the investor’s purchase.

In summary, trading volumes and asset levels are not true indications of an ETF’s liquidity; in reality, an ETF is at least as liquid as its underlying securities.

Tune into the next video in this series to better understand the metrics used in evaluating the secondary market efficiency of an ETF. And if you are interested in learning more about the lineup of ETFs at Thrivent Asset Management, connect with a dedicated Thrivent consultant serving regional and national accounts at ThriventETFs.com/contactus.