Exchange traded funds (ETFs) provide access to a diversified portfolio of securities such as stocks or bonds. They are flexible investment vehicles that can be used within a portfolio in many ways to meet different investment needs and objectives. Similar to stocks, ETFs can trade throughout the day on an exchange.
One of the most misunderstood aspects of ETFs is their liquidity. ETF liquidity has two components – the volume of units traded on an exchange and the liquidity of the individual securities in the ETF’s portfolio. ETFs are open-ended, meaning units can be created or redeemed based on investor demand. This process is managed by market makers who are tasked with providing ETF liquidity to a given market. How easily the market maker can deliver or sell securities depends on the liquidity of individual securities in the ETF portfolio.
The creation and redemption process occurs in the primary market. If there is demand for a particular ETF, a designated broker or market maker can create new units by delivering a basket of securities to an ETF sponsor. In return, the ETF sponsor delivers ETF units of equal value to the market maker, which the market maker then sells publicly on the exchange to meet investor demand. The reverse process is followed in case of redemptions, when the supply of units is larger than demand.
In the secondary market, investors buy and sell the units on the exchange without the ETF sponsor’s involvement. These transactions between individual investors are processed throughout the trading day at market prices.
The daily volume traded of an ETF is often incorrectly used as a reference point for liquidity. An ETF’s liquidity is determined by the liquidity of the underlying securities whereas trading volume is influenced by the activity of investors. If an ETF invests in securities that have limited supply or are difficult to trade, this may impact the market makers’ ability to create or redeem units of the ETF which may then affect the portfolio’s liquidity. However, Canadian-listed ETFs predominantly invest in liquid securities that trade on major exchanges around the world.
You are looking to buy an ETF that holds Canadian large-cap stocks, which you know represent ownership in large, in-demand companies. Your research turns up two ETFs that are almost identical in holdings and bid-ask spread:
For illustrative purposes only
At first glance, you may think that you should buy ETF X because it appears to be more liquid – there are more units changing hands with a small bid-ask spread. But, in reality, ETF Y is just as liquid as ETF X because it holds essentially the same securities, which are highly liquid. Facing a choice between two ETFs with similar liquidity, investors should then look to other factors such as product quality, level of service from each provider and management fees to make a decision.
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RBC Global Asset Management Inc. is Canada's largest fund company by assets under management (IFIC, as of August 31, 2017). Commissions, management fees and expenses all may be associated with investments in exchange-traded funds (ETFs). Please read the prospectus or Fund Facts document before investing. ETFs are not guaranteed, their values change frequently and past performance may not be repeated. ETF units are bought and sold at market price on a stock exchange and brokerage commissions will reduce returns. RBC ETFs do not seek to return any predetermined amount at maturity. Index returns do not represent RBC ETF returns. RBC ETFs are managed by RBC Global Asset Management Inc., an indirect wholly-owned subsidiary of Royal Bank of Canada. The indicated rates of return are the historical total returns for the periods including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, commission charges or income taxes payable by any unitholder that would have reduced returns.
RBC ETFs are available across Canada. The information contained on this site does not constitute an offer or solicitation to buy or sell any investment fund, security or other product, service or information to any resident of the U.S. or the U.K. or to anyone in any jurisdiction in which an offer or solicitation is not authorized or cannot legally be made or to any person to whom it is unlawful to make an offer or solicitation. The information is not intended to provide specific financial, investment, tax, legal or accounting advice for you, and should not be relied upon in that regard. You should not act or rely on the information without seeking the advice of a professional.
This information has been provided by RBC Global Asset Management Inc. (RBC GAM) and is for informational purposes only. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. The information contained herein is from sources believed to be reliable, but accuracy cannot be guaranteed. Commissions, management fees and expenses all may be associated with investments in exchange-traded funds (ETF). Please read the prospectus or Fund Facts document before investing. ETFs are not guaranteed, their values change frequently and past performance may not be repeated. ETF units are bought and sold at market price on a stock exchange and brokerage commissions will reduce returns. RBC ETFs do not seek to return any predetermined amount at maturity. Index returns do not represent RBC ETF returns. RBC ETFs are managed by RBC Global Asset Management Inc., an indirect wholly-owned subsidiary of Royal Bank of Canada.
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