ETF Education

Authorized participants (APs) are one of the types of major players at the epicenter of the ETF ecosystem. They are typically U.S.-registered broker-dealers or other financial institutions that have executed agreements with various ETF issuers. These agreements give them the right to create or redeem new ETF shares as demand fluctuates and are vital to the ETF structure.

A market maker provides liquidity and makes markets in ETFs. Most ETFs also have what is called a lead market maker, who is designated by the exchange to provide a measure of liquidity and ensure reasonable spreads and markets.  An AP has an agreement with an issuer to create and redeem ETF shares. Not all market makers are APs, but most market makers have access to the infrastructure of an AP. A market maker does not need to be an AP in order to provide competitive markets.

Average daily volume (ADV) does not measure the true liquidity capacity of an ETF. It is a simple measure of on-screen demand, not supply. The true liquidity capacity of an ETF resides in its underlying securities. This liquidity resource can easily be tapped to possibly trade multiples of ADV by utilizing your trading desk resources. This is something that the WisdomTree Capital Markets team can assist with and help guide you to the best resources to facilitate your trade with the best execution.

ETFs are at least as liquid as their underlying basket of securities. Implied liquidity is a more accurate way to measure the liquidity capacity of an ETF compared with the ADV of the ETF wrapper for equity ETFs. Implied liquidity is calculating how many ETF shares can be bought or sold in a single day without affecting the underlying securities. ETF implied liquidity first looks at how many shares of each underlying component are in a creation unit. The final output assumes that if transacting in the underlying securities, how many ETF shares would that translate into while being no more than 25% of the 30-day average volume of the least liquid security in the basket. ETF implied liquidity is a conservative measure of what can potentially be traded in ETF terms based on the ETF’s components.

The creation/redemption mechanism allows for the increase or decrease of ETF shares based on demand without affecting other investors of the fund. This is an important difference compared with a mutual fund, where any buying or selling in the fund affects all investors. If there is increasing demand for a specific ETF, new shares can be created to meet that demand in exchange for underlying assets; if demand decreases, shares can be reduced by exchanging ETF shares for assets. This flexible process is solely done by an AP. It is important to note that the investor never makes the decision to create or redeem; this is a back-office function determined by the broker.

The Capital Markets team at WisdomTree is a key resource for all ETF investors. We maintain relationships with all of the major trading desks, ranging from proprietary trading firms to global banks to a hybrid of the two to platform and custodial desks. We can easily work with you on determining who your resources are and how to best access them, and we can provide an introduction if needed. We are extremely familiar with the various nuances of the platform desks, so we are here to help make sure you receive the best trade execution experience possible.

Fixed income ETFs have multiple benefits. They allow investors to easily trade the fixed income asset class on an exchange, instead of over the counter, which is how fixed income assets are usually traded. Fixed income ETFs give clients transparency to their exposure by providing daily fund holdings. This is very different compared with a mutual fund, which discloses holdings only on a quarterly basis with a 90-day lag. Fixed income ETFs also have the benefit of potentially having a tighter bid/ask ETF spread than the underlying bonds. Lastly, investors can potentially access on-exchange liquidity, and no transaction has to occur in the underlying bonds. ETFs provide additional layers of liquidity.

While ETFs and stocks both trade on a stock exchange, there are some notable differences. Unlike a stock, which is a single security, an ETF is a wrapper made up of a basket of securities. The shares outstanding of an ETF can fluctuate with demand as it has another avenue of liquidity through the underlying basket. A stock has a finite number of shares that can be traded. Additionally, ETFs typically provide a more diverse exposure to a particular sector or country. Stocks provide exposure to one particular company.

• NAV - Represents the value of the ETF at their last price of the prior trading day. The ETF will always trade at a premium or discount to the last NAV that was struck the night before. Intraday Indicative Value is a better measure of ETF fair value on an intraday basis.
• Intraday Indicative Value (IV) - Represents the ETF price based on the last traded price of the underlying basket. For U.S. markets this price should closely align with the current ETF price. For international ETFs the IV becomes stale once the underlying market has closed for the day as the ETF begins to trade as proxy. That premium or discount from IV is based on expectations for the next trading day. This fair value of the ETF is calculated by using futures, the current U.S. markets or other correlated proxy’s. The IV will be similar to the current day NAV that will be struck that evening.
• Last Price - The last traded price across all exchanges.
• Official Closing Price - The official last price of the ETF on the primary listing exchange.