ETF Capital Markets Desk: ETF Liquidity Revisited

Two distinct camps of investors who want ETF liquidity, for different reasons.

    David Mann

    David Mann Head of Global ETF Capital Markets,Franklin Templeton

    David Mann revisits the ever-popular topic of liquidity in exchange-traded funds and posits sometimes taking risks in life can be worthwhile.

    It is hard to believe we just celebrated the three-year anniversary of our Capital Markets Corner blog! Over that time, we have posted more than 50 articles on a wide array of topics including exchange-traded funds (ETF) trends, trading best practices, misconceptions, US market structure and regulatory changes.

    My very first post was titled, “What Investors Look for in an ETF.” In fact, my whole initial series of blogs focused on some of the main misconceptions related to ETF liquidity, a topic that always comes up when discussing ETF trading, even today.

    Admittedly, back then I knew what was in store for our lineup given we were a newer entrant within the ETF space. Generally speaking, newer funds are smaller, volumes are lower and spreads are wider. The challenge was proving that even if the counting stats were lower, investors could still trade those funds easily (and they can!).

    And guess what? It has been very challenging getting some investors on board.

    Investors want ETF liquidity, and often make investing decisions based solely on a fund’s liquidity profile. What I did not fully appreciate as we first launched our products is that there are two distinct camps of investors who want ETF liquidity, for what I think are two completely different reasons:

    1) They want strength in numbers.

    Some investors like high average volumes because of the optics of bigger numbers being better and the added comfort of knowing that lots of other people are using/trading a certain ETF. Going with the crowd can feel like the better and safer choice. This phenomenon is not just an ETF issue.

    For example, I will admit that there are times I choose a restaurant based on the number of people eating there. In fact, a new restaurant opened up near my house that checked all the boxes: great menu, nice décor, solid selection of beer. But the first couple of times I walked by, it was usually empty so I avoided it. But guess what? My wife and I finally gave it a try, and it was great. And guess what else? It is now starting to get crowded. I am pretty sure there is an ETF lesson in there somewhere.

    If you’re not a foodie, perhaps a quote from hockey legend Wayne Gretzky would resonate: “You’ll always miss 100% of the shots you don’t take.”

    2) They think it will equate to reduced trading costs.

    These investors gravitate to higher-volume ETFs because of the perception that it is easier to enter and exit a position. Put another way, there is a perception that higher volumes and tighter spreads result in lower trading costs. That is not necessarily the case, and is a topic I have discussed in this forum repeatedly.

    I talked about it from the bid/ask spread angle in these posts:

    I talked about it from an ETF arbitrage/underlying basket angle in these posts:

    Three years later, I feel confident we are making progress in addressing the second point above. Furthermore, repeated trading conversations with all parts of the ETF ecosystem—investors, market makers, authorized participants, exchanges—have helped identify concerns and create possible solutions.

    As an example, we have implemented several innovative trading programs that we feel have greatly improved the liquidity in our funds to the point where the trading experience (and costs) in our funds should be no different than in those with higher volumes.

    The comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

    This information is intended for US residents only.

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