In essence the primary market is where ETF shares are created and redeemed and then they are publicly traded in secondary markets, helping to ensure liquidity as well as ensuring orderly and efficient trading.
We will have a look at the secondary market first, which is where investors and their advisers will encounter ETFs.
Advisers are used to dealing directly with fund managers or platforms when they invest their clients’ money. But for those that have taken the plunge, buying ETF shares has required a bit of a cultural shift, starting with thinking about how the secondary market works, including understanding pricing, spreads and liquidity.
Buyers and sellers of ETF shares trading on the stock exchange comprise the secondary market. Financial advisers can trade ETFs on behalf of their clients through stockbrokers or platforms, some of which simply execute trades on behalf of the adviser, while some can also offer advice and guidance to advisers and their investors.
Market makers provide continuously updated on-screen buy (‘offer’) and sell (‘bid’) quotes at which they are willing to deal in ETFs throughout the trading day. They also provide liquidity for buy and sell orders in the secondary market for the ETF.
The difference between the bid and the offer price is known as the bid-offer spread. Under stock exchange rules, market makers are obliged to ensure that the spread remains below a certain percentage of the price. The availability of real-time quotes means advisers have the option to deal at a known price, instead of an unknown future price, as with many traditional mutual funds.
A number of factors influence the market price for an ETF, including the share price movement of the underlying securities, exchange rate movements for international funds and investor demand for the ETF. Issuers calculate and publish the closing net asset value of the ETF daily. They base the net asset value on the closing market prices of the securities in the underlying portfolio after fees and expenses. Although ETFs can trade above or below the intraday NAV of the underlying index at a given point during the day, underlying market forces generally keep ETFs trading near their intraday NAV.
Brokers and platform usually provide their clients with up-to-the-minute ETF prices using subscription data terminals. You can also find delayed intraday prices for free from the stock exchange or on many online services by searching for the ETF’s name or alphanumeric stock market ‘ticker’. You can find the ETF ticker on the ETF factsheet, which normally appears on the issuer’s website. You can also monitor ETF share daily closing prices on the issuer’s website, which should provide a daily closing price and the closing NAV.
Narrow spreads and liquid markets are more attractive to investors, increasing the demand for securities which, in turn, creates higher trading volumes. Market makers earn their revenue from trading and have a strong motivation to maintain tight ETF bid-offer spreads. If spreads widen too far it stifles demand and may result in lower volumes of business for the market maker. However ETF spreads can widen during periods of market uncertainty, just as they do with company shares traded on the stock exchange.
