Clearing up the misconception: ETF trade volume vs. liquidity

A client recently expressed interest in the Natixis Loomis Sayles Focused Growth ETF (LSGR) but had concerns about its low trading volume. In our experience, this is the most common but easily addressed misconception about ETF liquidity.

Indeed, LSGR has a 30-day average trading volume (ADV) of roughly 10,611  shares on the secondary market (as of 1/10/2025). This low average trade volume can be common in relatively new ETFs like LSGR, which launched in June 2023. However, an investor could buy up to roughly 37 million shares (over $1.4 billion notional value) at the current market quote or better. How is this possible?

Where’s the liquidity?

As illustrated below, exchange-traded fund (ETF) liquidity is determined by trading volume of all underlying holdings in the portfolio creation basket. Based on LSGR’s holdings and weights (as of 1/10/2025), market makers¹ would be willing to facilitate new buy orders up to 37 million shares at the current National Best Bid/Offer² (NBBO) asking price of $38.26 or lower, depending on trade size. This equates to a notional value of over $1.4 billion. This secondary market trade would likely flow into the primary market, as new shares would need to be created to meet this outsized demand.

"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 $38.26 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 197,000 shares of LSGR was executed on 9/27/24 at a share price of $35.32 for a total value of $6.95 million. Since ETF shares can be created on demand, the order was executed at a price 3 cents above the iNAV ($35.29) and 1 cent below the NBBO ask ($35.33) at the time of the trade. This amounts to cost savings of $1,970 for executing a large block order vs. trading at on-screen levels.

ETF example 2: A large lot sale

Would the trading execution on ETFs of similar size and average trade volume be equally efficient for a sell order? The answer is yes. As an example, on 9/4/24, a large Natixis Vaughan Select ETF (VNSE) block sale of 243,000 shares was executed at $33.44 for a total value of $7.89 million. At the time, the 30-day ADV for VNSE was about 11,266 shares. However, given that ETF shares can be redeemed directly by a liquidity provider, this order was executed at 1 cent below the iNAV and 3 cents above the NBBO bid at the time of the trade. This amounts to cost savings of $7,290 for executing a large block order as opposed to trading at on-screen levels.