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.