The Potential Pitfalls of ETPs' Intraday Liquidity

It is crucial for investors to understand the sources of ETP liquidity, how to measure it and how to manage ETP transactions in challenging market environments

Ben Johnson 16 September, 2011 | 8:44AM
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Recent events such as the “Flash Crash”, the Japanese tsunami, and the bout of heightened market volatility experienced in August have brought the potential pitfalls of intraday liquidity—often touted as a key selling point of exchange-traded products (ETPs)—into plain sight. Through these periods, there have been several instances where market makers in ETP shares have headed for the hills and taken their promises to make orderly and accurate markets in these products with them. Now, more than ever, it is crucial for investors to understand the sources of ETP liquidity, how to measure it, and how to manage ETP transactions in challenging market environments.

Sources of ETP Liquidity
Exchange-trade products (ETPs) have two key sources of liquidity: the primary and secondary markets. The primary market is where ETPs are born. Within the primary market, authorised participants (APs) can create new ETP shares by delivering cash or securities to the ETP provider in exchange for new ETP shares. APs can hold these shares and ultimately redeem them for cash or securities from the provider, or they can turn around and sell them on the secondary market.

For investors looking to buy an ETP, secondary market liquidity is what matters most.

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Ben Johnson

Ben Johnson  is director of passive funds research at Morningstar.