Trading and liquidity

It is easy to invest in ETFs. Fund units are bought and sold on the stock exchange, just like stocks. Trading with ETFs has the same settlement schedule as for stocks (T+2). This make ETFs well suited in a portfolio consisting of individual stocks.

An order is placed through your broker on the number of fund units that you want to buy or sell. To register the ETF-units a custody account or Swedish VP-account is required. When ETFs are bought and sold, a commission is paid to your broker.     

Market maker

Xact has agreements with several independent market makers and authorised participants who provide liquidity in the ETFs. Based on the fund’s real-time value (the fund’s iNAV) the market makers continually set bid and ask prices which makes it possible to buy and sell ETF units at any time during the day.

Liquidity and spread are based on the structure of the underlying market

An ETF reflects the trend of a specific underlying market index, such as a commodity or equity index. The market makers set prices for the respective ETF based on the price change in the underlying market.

Both liquidity and the spread between the bid and ask price are dependent on the structure of the underlying market, which also means that liquidity and spreads in the ETF can continuously vary intraday. However, the presence of market makers means that there is liquidity and trading opportunity in the ETF, even if the numbers of trades in the ETFs itself are few. 

The liquidity of an ETF is not determined by the turnover of the ETF

A common misunderstanding is that an ETF with low turnover or few trades has poor liquidity, as is the case with individual equities. Based on this misunderstanding, a large order would thus have a negative impact on the price of an ETF with low trading.

Unlike equity trading, where only a limited number of equities are available for trading in the market, ETFs have no such limitation.

Creation and Redemption

ETFs have a unique “Creation & Redemption” procedure whereby market makers and authorised participants can create and redeem fund units at any time directly with the fund, thus ensuring that there is always a balance in the market between supply and demand for units. If demand outpaces supply, the market maker will create new units and, conversely, if selling pressure on the ETF is greater than demand, the units can be redeemed with the fund.

In exchange, as payment for the new units, the underlying basket of securities is provided to the fund. When redeeming units, the fund returns the underlying basket for the corresponding value of the units redeemed.

Because of the ability to create and redeem units in the underlying basket, it is the liquidity of the underlying assets that determines the liquidity of the ETF. The extent to which an authorised participant can execute transactions in the underlying securities without “moving the market” is a good indication of the size of the trading volume in the ETF that would affect its value. Since most ETFs invest in highly liquid securities, these ETFs are actually much more liquid than turnover in the ETF itself shows.

Arbitrage opportunities keep prices in line with NAV

During the trading day, market makers quote a price on the ETF as close as possible to the fund’s net asset value in real time (iNAV). If the quoted price should deviate from the theoretically correct value of the ETF, an arbitrage opportunity has occurred that could be exploited by the authorised participants.

If a too high price (in relation to the correct value of the ETF) is quoted, the authorised participant can sell the ETF at the “too high” price and simultaneously buy the underlying basket at a lower (correct) price. Because it is possible to create new fund units, the authorised participant can sell ETF units that he still does not own; in other words, the ETF can be sold short. With the purchased underlying basket of securities in exchange, the authorised participant can actually create new fund units in the fund and deliver them to the person to whom he just sold the units. A risk-free profit thus arises between the price at which the authorised participant sold the (over-priced) ETF units in the market and the price paid for the underlying basket delivered to the fund.

Conversely, the authorised participant can sell short the equities basket when the ETF units are quoted at a price lower than its correct theoretical value. In exchange for redeemed ETF units the authorised participant gets the underlying equities basket in return from the fund and thus can deliver it to the buyer of the equities.

This unique ceation & redemption procedure in an ETF thus fulfils yet another important function for trading in ETFs; it keeps the quoted prices for an ETF in line with its theoretically correct value.

Primary market and secondary market

In order to maintain trading and liquidity in fund units, market makers and authorised participants can create and redeem fund units directly with the fund. This takes place in the primary market. For example, a request to create fund units occurs when demand is high on the stock market or the secondary market and new units are needed. In exchange for new fund units, the fund receives the underlying basket of securities which serves as the benchmark index and for the value that corresponds to the newly issued fund units. The opposite occurs when units are redeemed, when the fund returns the underlying basket in exchange for the redeemed units. Redemption and creation of units in the primary market are only possible for large amounts in order to keep the fund’s administrative expenses low.

Fund units created in the primary market are bought and sold on the stock exchange at a price that is close to the theoretically correct value of the ETF (iNAV).

The primary market is important

The primary market fulfils an important function. The ability of market makers and authorised participants to create and redeem fund units in the primary market keeps quoted buy and sell prices as close as possible to the theoretically correct price (iNAV). If quoted prices on the stock exchange deviate from the theoretical value of the ETF, an arbitrage opportunity arises, which can then be used by other authorised participants who can redeem ETF units in exchange for the underlying basket, and vice versa. Read more here.

On Exchange

In Sweden, Xact’s ETFs are traded on the Nasdaq OMX Stockholm and on Burgundy. Trading starts at 9:00:30 am with an opening auction and ends at 5:25 pm, without a closing auction. During this time trading is carried out in exactly the same way as trading in equities. Independent market makers continuously set bid and ask prices for the ETFs and ensure good liquidity for the fund units, even for large orders. 

OTC

Large trades can also be executed OTC (Over the Counter), or off-screen. The investor directly contacts a market maker or authorised participant, who quotes the price of the requested transaction. Buyers and sellers can agree on terms that would not otherwise have been possible in stock exchange transactions. For example, the parties may agree to close a transaction at a price at a certain time later in the day, or at closing on a certain day. Trades are usually reported to the relevant stock exchange.

At NAV

For investors who wish to trade at the fund’s NAV, market makers often offer their customers the ability to trade the ETF at its NAV on an OTC basis. 

Base currency and trading currency

The base currency is the currency in which the fund’s NAV (Net Asset Value) is expressed. For Xact’s ETFs, this currency is most commonly SEK or EUR.

The trading currency is the currency in which the fund is quoted and traded on each stock exchange. On the Nasdaq OMX Stockholm and on Burgundy, Xact’s ETFs are traded in SEK, and on Oslo Børs they are traded in NOK.

Currency exposure

Xact’s ETFs are not currency-hedged. This means that a currency exposure arises if the underlying basket of assets is traded in a currency other than the ETF’s trading currency. An investment in Xact Commodity, which tracks the price of 15 different commodities, with all of them except electricity priced in USD, thus gives rise to currency exposure between SEK and USD. 

The market makers’ pricing of ETFs with an underlying basket in a currency other than the trading currency is established based on the prevailing spot rate between the trading currency and the currencies of the underlying basket.

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This information is updated every 15th minute from Millistream. Xact does not assume any liability for errors in the information.

Data source

This information is updated every 15th minute from Handelsbanken. Xact does not assume any liability for errors in the information.