Here We Go Again: The ETF “Volume” Fallacy

Here we go again.

We do not pretend to be ETF sponsors (we’re not) and we do not pretend to be APs (we’re not), but we do pretend to understand a very simple concept which Howard Marks explained as follows more than two years ago:

The ETF can’t be more liquid than the underlying.

That’s unassailable.

Note that what that doesn’t say is that the underlying isn’t liquid. The underlying may very well be liquid. Which means the ETF is commensurately liquid. Which means if you own the ETF you have nothing to worry about.

But the ETF can’t be more liquid than what it represents. Period. Trust us, there are dead philosophers spinning in their graves every time someone asserts or otherwise suggests that ETFs can be more liquid than the securities that lie beneath them.

Well, those corpses are spinning today because BofAML is out droppin’ some “knowledge” about ETF liquidity.

Via BofAML

ETFs and ETF options have seen a huge increase in liquidity.

ETFs have democratized financial markets in recent years by allowing both small and large investors to express complex macro ideas in a single, standardized instrument. While liquidity in single stock equities has stagnated over the past 5 years, ETF share volume has risen 50%. Today, 5 of the 10 most liquid instruments in equity markets are ETFs, and ETFs account for 20% of all US cash equity volume compared with 10% pre GFC. Naturally, this growth in liquidity has fed into ETF options markets too, and we are launching a [new series of notes] to help our clients to better express asset allocation and tactical macro ideas through ETF options.

This is the same argument as that famously made by the fictional “CitiWide Change Bank” on SNL in 1988. Put simply: you can’t explain away an absurd proposition by citing “volume.”


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