"Implied liquidity” is a measure of an ETF’s potential trading volume based on its components and liquidity profile. In the example above, FactSet Research Systems Inc. (FDS) would be considered the least liquid basket holding, per its ADV. The least liquid ETF holding typically determines how much of the ETF could be bought or sold on a given day without causing undue friction3 in the underlying security prices. Remember, when ETF units are created or redeemed in a standard in-kind primary market order, the full basket of underlying holdings will be included in the transaction.
Executing an ETF Trade
In our example, a very large buy could be fully executed at the market quote of $25.85 or lower (even if only 100 shares are being offered at the NBBO on-screen). Economies of scale play a key role as liquidity providers’ fixed costs to create/redeem ETF shares become a smaller percentage of the overall transaction for large trades. Typically, the best possible execution price on these large purchases is the intraday net asset value (iNAV)4, as liquidity providers would ideally avoid selling shares for less than the underlying components’ actual worth.
To optimize trade execution, we suggest using limit orders5 instead of market orders for on-screen trading. For large lot trades (over roughly 2,000 shares), financial advisors can consult with an ETF issuer’s capital markets team for advice on best practices or contact their dedicated broker/dealer ETF block trading desk to facilitate the order.
Let’s test our theory by considering two real-world Natixis ETF transactions.
ETF example 1: A large lot purchase
A large block purchase of 199,000 shares of LSGR was executed on the launch date (6/29/2023) at a share price of $25.04 for a total value of $4.98 million. As it was the first trading day, there was minimal secondary market volume and limited shareholders. However, since ETF shares can be created on demand, the order was executed at a price 1 cent above the iNAV ($25.03) and 3 cents below the NBBO ask ($25.07) at the time of the trade. This amounts to cost savings of $5,970 for executing a large block order vs trading at on-screen levels.