By now, advisors and even most investors understand the way exchange-traded funds (ETFs) operate. One issue, however, that seems to be a cause of confusion is the role of trading volume.
Trading volume has always been the yardstick to measure the success of any exchange-traded financial product, and ETFs are no different. It was the spectacular growth in trading volume of the earliest ETFs which inspired fund sponsors to create new ETFs, several of which are now volume leaders themselves.
So let’s take a look at ETF Trading Volume 101. First, there are really two worlds of ETFs: The 20 largest ETFs together account for about 80% of total ETF trading volume, and the roughly 800 others account for only 20% of ETF trading activity.
With trading volumes equal to or greater than some of the most actively traded stocks, and ETFs accounting for about one-third of all equity trading volume as of mid-2009, according to Index Universe, there is little question that some ETFs are liquid enough for any type of investor, and most ETFs are liquid enough for every investor. Take August 26, 2010, a day on which bid/ask spreads at Vanguard varied from as little as 0.01% of the share price for the Short-Term Bond ETF (BSV) and the Total Bond Market Fund (BND) to a high of 0.36% for the Long-Term Corporate Bond ETF (VCLT). There are dozens of ETFs, however, that trade less than 1,000 shares a day, which may have fairly wide bid/ask spreads on any given occasion.
Trading Volume Doesn’t necessarily Equal Liquidity