Why ‘SPY’ Is King Of Liquidity

April 08, 2019

ETF.com: Wow. It's astounding to realize how much more volume SPY trades than even some of its constituents. SPY even trades more in volume than Apple (AAPL), day-to-day.

Bartolini: Yes. It trades more than the entire GDP of Japan, and more than every single Dow Jones index stock combined. Essentially, you have to go down to the 92nd company in the S&P 500 ranked by market cap before you surpass SPY's trading volume, meaning that the top 92 combined trade less than SPY does.

ETF.com:  So how big a trade would you need before you actually moved the market in SPY?

Bartolini: It would require a trade of gargantuan size, one that we have never seen before and will likely never, ever see. In October, when the U.S. equity market sold off, equities traded something in the neighborhood of $300 billion. But ETFs [accounted for] only around 3.5% of underlying stock volume.

So it’s a big pool of liquidity out there in the single-stock space. For SPY to move the market would be, in my experience, impossible.

ETF.com: What do you think most investors really just don't understand about ETF liquidity?

Bartolini: Three things. The first is understanding what we mean by "liquidity." For example, a lot of peple look at average shares traded, because that's how you look at single stocks; like, Exxon (XOM) traded 50,000 shares, etc. In ETF land, though, you really want to focus on the dollar volume.

ETF.com: Why is that?

Bartolini: Because creation-unit size is different, and stock price is vastly different between a lot of these instruments that seemingly trade on the same type of security. You can have a U.S. equity fund with a $5 share price and one with a $300 share price.

You also need to think of that dollar-trading volume in relation to the rest of the ETF industry. A fund like the SPDR S&P Retail ETF (XRT) has a sizable amount of liquidity; it trades $300 million a day. Pretty good.

But that $300 million is 87% of its assets. So XRT can be a $1 billion fund one day, then a $300 million fund the next, because it's so heavily traded. Understanding those dynamics is important. XRT, while it may not trade as much as SPY, still has a strong liquidity profile. And it has basically 382% of its assets sold short right now, and 191% of its assets in options volume.  

Those three things—high trading volume, options and short interest—are what really make a liquid product, even though its asset base may only be $300 million to $400 million.

ETF.com: Does ETF liquidity still matter if you're a smaller investor, with a smaller asset base who isn't trading as much?

Bartolini: It matters to everybody. Bid/ask spreads are paid by everybody. You might not trade quarterly, monthly or even annually, but you have to think about how important trading costs are to your overall portfolio implementation.

The last thing I'll say is how important liquidity is during times of volatility, especially when you're heavily trading a portfolio. Going for the product with the lowest expense ratio may not actually end up being the lowest-cost product.

We’re constantly hearing, "Well, in periods of volatility, I just won't trade." While that may be true in most instances, there are some periods, like in the fourth quarter, where I'm hard-pressed to think no one was rebalancing their portfolios heading into year-end. Having the ability to tap into something extremely liquid, with consistency during periods of volatility—but also tranquility—can be additive to the portfolio construction process.

Contact Lara Crigger at [email protected]

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