Smart investing with ETFs

ETFs are experiencing increasing demand from investors due to the continuing trend towards passive investments. More and more private investors are using ETFs, for example to build up long-term assets. This rising demand for ETFs is also reflected in the increasing liquidity. Liquidity in exchange trading describes the extent to which a security can be bought and sold at any time. The higher the demand, the more liquid a product can be traded. This leads to lower transaction costs for investors and traders. Both sides benefit from liquid markets as they can trade securities immediately and at low cost.

Trading costs are made up of two components: The direct or explicit trading costs of a transaction, which arise from the settlement of the order by banks and exchanges - these include fees and commissions charged directly to investors. And the indirect or implicit trading costs of a transaction, which result from the spread, i.e. the bid-ask spread, and the underlying trading volume. The latter are only comprehensible to a limited extent, as they depend on the composition of the order book and are not shown directly. Nevertheless, they are usually even more important for investors: they can fluctuate by up to 30 percent 

in the course of a trading day. Evaluations by Deutsche Börse have shown, for example, that indirect trading costs are lowest for many ETFs on average around midday, i.e. between 12:00 and 1:00 p.m. The explanation is probably due to the fact that price-sensitive information rarely comes up at this time.

Determining liquidity 

There are several ways to assess the liquidity of an ETF, including, for example, the intraday Xetra liquidity measure or the number of designated sponsors. 

iXLM and XLM

An overview of the implicit trading costs of ETFs is provided by the Intraday Xetra Liquidity Measure (iXLM), which Deutsche Börse has introduced in 2019 in addition to the already established liquidity measure XLM and which is published once a month in the ETF statistics. To determine the most favourable trading time based on historical data, the intraday XLM is calculated at half-hourly intervals for an order size of €100,000. The Intraday XLM is expressed in basis points and allows a comparison of the liquidity development within a trading day for more than 1,500 ETFs. Investors can use this information to determine the period during which the trading costs of an ETF on Xetra were particularly favourable and incorporate this information in future decisions. 

An evaluation across all ETFs has shown that the implicit transaction costs are up to 30 percent lower at the most favourable time than at the least favourable time during the day. Especially at the beginning of trading, the spreads are generally higher. Basically, the lower the iXLM, the lower the implicit trading costs.

Designated Sponsors 

In addition to iXLM, the number of Designated Sponsors on Xetra is an important indicator for the liquidity of ETFs. Designated Sponsors are trading participants who commit themselves to the exchange to provide liquidity on an ongoing basis and thereby comply with certain minimum requirements. These requirements include the minimum quotation volume and the maximum spread. As a rule, the higher the number of Designated Sponsors in an ETF, the greater the liquidity. Deutsche Börse publishes an overview of the Designated Sponsors for each ETF on boerse-frankfurt.com.  

Size of an ETF

In addition, the level of assets under management in an ETF can also have a positive effect on its liquidity. This can be explained by the fact that large fund assets are often also an indicator for many

investors already invested. These investors then also contribute to the liquidity of an ETF with their buy and sell orders. Investors can also find information on the fund size of an ETF on the data sheet of the respective ETF at boerse-frankfurt.com.

Order book depth

A further indication of liquidity is also the order book depth, i.e. the number of limit levels that are occupied by orders and quotes from trading participants. With less liquid ETFs, only the first limit levels of the order book tend to be filled with orders. With more liquid ETFs, the orders are distributed across the entire limit levels in the order book. Information on order book depth can be viewed via the open Xetra order book.

When is the use of liquidity indicators appropriate?

The indicators described above can provide guidance in selecting and placing orders for an ETF. However, past trading activity does not necessarily reflect the future. For ETFs that track a comparable index, however, the use of indicators can be useful because individual product characteristics can always influence the liquidity of a single ETF.