Active exchange traded managed funds – understanding liquidity
A key benefit for investors in active exchange traded managed funds is their tradability.
Unlike traditional funds, exchange traded managed funds can be bought and sold at any time through a stock exchange just like shares. But since they trade like shares, investors may mistakenly attempt to evaluate their liquidity in the same way they might for shares. This gives rise to one of the most common misunderstandings about these types of funds, namely, that ‘on-screen’ volume equates to liquidity.
This misperception reflects the fact that, by comparing exchange traded managed funds to shares, many investors assume that fund liquidity is driven by the same factors that drive the liquidity of shares, namely:
- the fund’s size (funds under management);
- average daily volume traded; or
- the volume of units quoted ‘on screen’ at any given time.
For exchange traded managed funds, however, these measures often vastly understate their effective liquidity. As we’ll see, the best measure of a fund’s liquidity is the liquidity of the underlying portfolio of securities (such as company shares) it holds. In most cases, therefore, this means exchange traded managed funds are highly liquid.
Open-ended structure facilitates liquidity
Although exchange traded managed funds trade like shares, one cannot use the same criteria to evaluate their liquidity, due to their open-ended structure – which effectively means their supply of units on offer can adjust to demand through the trading day.
In the case of shares, for example, the number of outstanding shares available for trading on any given day is fixed – irrespective of the level of investor demand. As a result, the ability of the market to accommodate swings in demand without affecting prices too much is quite rightly related to the average daily trading volume of these shares.
Exchange traded managed funds, on the other hand, are open-ended funds – meaning supply can adjust to swings in demand throughout the trading day. How so? Each fund trading on the ASX acts as its own market maker, meaning that it will set bids/offers for investors during the day, and then issue or cancel units according to its net position in units bought or sold on the exchange that day.
Indeed, unlike a typical company that lists its shares on the market (including listed investment companies (LICs)), should investor demand exceed what is currently available “on screen”, the fund as market maker can simply create more units to meet the demand. Similarly, units can also be cancelled should supply exceed demand. The volume displayed for sale or purchase at any given moment of the trading day, therefore, is really only a small glimpse of what is really available.
Active exchange traded managed funds are as liquid as their underlying holdings
Given the way exchange traded managed funds work, their “true” daily liquidity is best reflected by the average daily volume of their underlying holdings. As seen in the example below – using the AMP Capital Global Infrastructure Securities Fund (Unhedged) (Managed Fund), ASX code: GLIN – while there was only around $1.5 million worth of the fund available for sale or purchase at the time of this snapshot, the “true” daily liquidity of its underlying constituents was actually around $3.5 billion.
The AMP Capital exchange traded managed funds have underlying portfolios that are highly liquid, which contributes to robust liquidity levels and generally ensures that the price of the fund closely reflects the value of the underlying portfolio.
Tips on trading active exchange traded managed funds
Despite their unique advantages, some care is still required in trading exchange traded managed funds, especially if the intended volumes are relatively large. Limited quantities of fund units might be shown for sale or purchase at the best bid and offer prices at any particular moment. As with any normal quote screen, other traders or investors may also have stock available for sale or purchase at less favourable prices.
As a result, as with trading company shares, investors should refrain from simply placing large “at market” orders – as there is the risk of having one’s order cascade down and being filled at less than the best prices possible. In these cases, it’s better to stagger trades by placing smaller market or limit orders that do not exceed the volumes currently available at the best prices on offer.
Unlike trading in company shares, however, once an exchange traded managed fund trade is completed, the fund as market maker will typically quickly replenish the volumes available at these same best prices – unless the NAV has suddenly changed.
And if in doubt about a fund’s underlying NAV, AMP Capital exchange traded managed funds have real-time estimations (indicative net asset values or “iNAVs”) available through the trading day on our website or via an ASX iNAV ticker.
Investors should be aware of the risks of liquidity. Although the units are quoted on the AQUA market of the ASX, there can be no assurance that there will be a liquid market for units, and no assurance that there will be a liquid market for the Fund’s investments.
As always investors should remember to read the Product Disclosure Statement (PDS) of each exchange traded managed fund prior to investing.
Find out more about AMP Capital's active exchange traded managed funds - Learn more here.
About the author
Paul Gambale is Senior Product Owner - Innovation and New Ventures at AMP Capital
Note: adapted from BetaShares Blog article “ETF Liquidity: will it be there when I need it?” by Louis Crous, 3 March 2015.