ETFs’ liquidity under question

By Rebekah Tunstead | 15 May 2019

Despite disagreement over the liquidity level of exchange traded funds (ETFs) thanks to the volume number of funds that are traded off-exchange, ETFs remain liquid, said Deborah Fuhr founder of ETFGI at a conference in London this week. However, not everyone agrees.

Europe’s Market in Financial Instruments Directive (Mifid II) requires all ETFs to be reported. When many expected the trades to go on exchange post-Mifid II according to Fuhr, the majority have gone to request for quote platforms, which has caused some confusion around ETF liquidity.

“Instead, what we’ve seen is 70% of the trades are going to RFQ platforms. That means that the trades are not on exchange, and so many people feel that ETFs in Europe are not liquid,” said Fuhr.

“That is not true because the real liquidity is liquidity of the underlying, but you do need to understand the nuances of ETFs in different markets so that you don’t have a misunderstanding,” she said.

On May 9, Moody’s investor service published a report stating that although ETFs had seen rapid growth because of a current calm environment, an ETF’s ability to withstand liquidity risk is dependent on its underlying market.

"In the event of a liquidity drought in underlying markets, market makers would likely reflect this risk in their ETF quotes. So in effect, ETFs track not only the performance of their underlying assets, but also the liquidity of these assets," according to Fadi Abdel Massih, a Moody's assistant vice president-analyst.

On May 8, etfexpress reported that investors had put $20.9 (60% of total inflows) into EMEA-listed fixed income ETFs during the first quarter.

“ETFs are really starting to take off now. I still believe we are in the early phases although they’re going to be turning 20 years old in Europe, and 30 years old in Canada,” said Fuhr. “Today, about 80% of institutions with assets over 10bn use ETFs in some way.”

“We will soon break through the $4trn mark for ETFs domiciled in the US, we are very close to that right now… we find that institutions in 41 countries use ETFs domiciled in the US.”

However, concerning is the level of domination by three firms and it looks set to continue.

 “One of the challenges we do have in the ETF industry, I mention the concentration of the top three managers accounting for 69% of the assets. Of the 7,700 ETFs, only 690 have individually gathered over a $1bn and they account for 86% of that $5.6trn. So, we have a lot of big liquid sharing star ETFs, and we have a lot of really small ones. Many investors when they invest, can’t be more than 10% or 20% of the assets, and then that tends to be a sort of self-fulfilling prophecy as you get bigger, you tend to get bigger because more people use it.”

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