TPA’s analysis of stocks in ETF’s reveals widespread illiquidity that could cause major dislocations in the next market downturn Many large and small cap stocks have multiple days of average trading volume tied up in ETFs. 


Using the bi-monthly report TPA ETF Liquidity Alert, clients can now:

1.    Scan portfolios for stocks that pose undue potential risk 
2.    Use ETF risk to decide between stocks with similar fundamental strengths
3.    Monitor overall ETF liquidity to determine if the situation has worsened or improved over time
4.    Configure strategies for the next downturn


TPA believes ETF stock liquidity should be a consideration when picking stocks for a portfolio.  In fact, understanding ETF stock liquidity should probably be the fiduciary responsibility of all money managers.

We specifically focus on trading volume, because this is the best measure of liquidity if the underlying stocks in an ETF have to be bought or sold.  Many market participants (liquidity providers and authorized participants) point to percentage of outstanding shares or float when discussing the liquidity of stocks in an ETF, but these outstanding or float shares will not matter on the day when many owners of an ETFs decide to sell simultaneously while the market is declining.


U.S. - There is widespread illiquidity relative to average trading volume for stocks in ETFs.  TPA found that out of all U.S stocks with market caps above $1 billion (over 1800 stocks):

  • 127 stocks (6%) have 30 or more days trading volume in ETFs

  • 228 stocks (12%) have 25 or more days trading volume in ETFs

  • 400 stocks (21%) have 20 or more days trading volume in ETFs

  • 646 stocks (34%) have 15 or more days trading volume in ETFs

  • 1014 stocks (54%) have 10 or more days trading volume in ETFs

  • The average days trading volume in ETFs for all the U.S. stocks with market cap above $1 billion is 13 days.


International - The illiquidity in non-U.S. stocks is even worse.  TPA’s analysis using the S&P1200 Global Index with the S&P500 stocks removed, found that of the close to 700 international stocks remaining:

  • 103 stocks (14%) have 30 or more days trading volume in ETFs

  • 160 stocks (22%) have 25 or more days trading volume in ETFs

  • 247 stocks (34%) have 20 or more days trading volume in ETFs

  • 372 stocks (51%) have 15 or more days trading volume in ETFs

  • 511 stocks (71%) have 10 or more days trading volume in ETFs

  • For all the international stocks the average market cap (U.S.$) is $31B and average trading volume in ETFs is 17 days.


A section of TPA’s report is displayed below. Using JNJ as an example:

  • 6.36% of JNJ outstanding is in ETFs

  • Outstanding = 2,684,000,000 shares

  • Shares in ETF = 170,702,400

  • 30-day average trading volume = 5,609,765 shares

  • ETF shares expressed as daily volume = 170,702,400/5,609,765 = 30.34 days


Below is part of the new report…




Of course, not all of the stock in ETFs would be sold on any given day, but even if investors just tried to sell 10% in a big decline, ETF selling would still be 3 times the average daily volume for JNJ.


I was a head trader for over a decade.  From a trading desk perspective, money managers normally try to sell the most liquid things (what they can sell) in their portfolio when trying to raise cash in a fast market.  ETFs would then be the obvious choice for managers looking to sell in order to raise cash.


The table below explains why so much JNJ is held in ETFs.  133 ETFs have JNJ as one of the top 15 holdings.  The top 25, by weighting, are shown below.




Below are the top 10 stocks by trading volume in ETFs.  Here the illiquidity will be most severe in any rapid market decline.  (Below is part of the new report)



There have already been several instances of major dislocations associated with automated trading.  These periods are well explained in the recent Barrons article entitled “Black Monday 2.0: The Next Machine-Driven Meltdown”  Most recently, August 24, 2015 saw huge price declines and trading halts directly connected with the trading of ETFs.


August 24. 2015 was the first real test of a large quick market decline and it produced large dislocations due to the inability to arbitrage ETFs vs. the underlying many stocks in volatile environment. 






Many ETFs were halted for trading. Per the WSJ, trading halts reported on 8/24/15 were almost 40 times the daily average for the year (see table below).  In the morning there were huge dislocations such as the ETFs DVY down 35% (AUM $13B), RSP down 43% ($10B), and HACK down 32% (AUM $1.2B).  There were over 400 stock halts in the morning. 


Stocks eventually recovered, but it took 3 months.  They then made new lows in February 2016 as the hangover from the crash lingered, but the potential problem has only increased.  There are now 33% more assets in ETFs than in 2015 (see table below).

There are now 33% more assets in ETFs than in 2015.



TPA is not stating that in a big decline a huge percentage of assets would be sold, only that if even some ETFs needed  to be sold in a short timeframe, it would not be easy and that ETF-stock liquidity should be a consideration and even a fiduciary responsibility when picking stocks for a given portfolio.                                                                                                             


Current Problems:

  • INDUSTRY BIAS -the bias by experts and market participants is to promote ETFs and largely ignore liquidity issues.  Any questions about the risk of ETFs are quickly brushed aside as ridiculous.

  1. At a recent conference several industry leaders responded to questions about ETFs, by saying that they did not believe ETFs will be a problem, “because they have not been a problem”. 

  2. An ETF expert with one brokerage told me that only something like a “nuclear war” would set of a situation that would be a problem for ETFs.  1. There was no nuclear war to trigger 2015 and 2. Can you say “North Korea”?.

  3. With volumes low and decreasing, ETFs seem like the only way left for the industry to operate.  This is a self-perpetuating cycle.  ETFs and other passive investment vehicles are propelling lower volumes and make the financial industry increasingly dependent on ETFs, which leads to lower volumes, etc…..


  • RELIANCE ON RECENT HISTORY AS PROOF - Reliance on “nothing bad has happened yet” reasoning is faulty.  The timeframe for reference is actually quite short and mostly occurred during the second longest bull market in history with stocks mostly headed higher.


  • LIQUIDITY PERCEPTION - Perception by market participants that ETFs are liquid – the TPA Liquidity Alert Report refutes this claim.


  • LOW RISK PERCEPTION - Perception that ETF holders have are insulated from risk because of diversification.  It is true that single stock risk (alpha) is reduced by holding ETFs, but that does not mean that ETFs are not a basket of securities that will respond in a very similar way to an overall market sell-off (Beta). Unfortunately, this type of idea was well-circulated from 2003 to 2008 when investors were under the misconception that a basket of mortgage backed securities eliminated real estate risk through diversification.


  • CLAIM THAT ETFS ARE RELATIVELY SMALL COMPARED TO ALL INVESTMENT ASSETS – it is true that the AUM in ETFs is still dwarfed by assets in Pension Funds, 401ks, Mutual Funds, and Hedge Funds, but the focus should be on what happens at the margin since this is what determines asset pricing.  The demand vs. supply balance each minute, hour, and day determine prices for stocks and in turn will determine performance for all asset managers.  Focusing on the average daily volume in underlying stock is the best way to identify liquidity.


Contact TPA for more information or to begin receiving the ETF Liquidity Alert.


Two Examples of ETF related illiquidity are provided below:

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