3 ETF Liquidity Myths That Can Raise Client Costs

• A $10 million position example showed a fund with 0.10% fees but 0.01% spread costing 0.11% total versus 0.12% for a 0.07% fee fund with 0.05% spread, with the gap widening on larger trades
• Among the 100 largest U.S. equity ETFs, State Street found no correlation between expense ratios and average bid-ask spreads, meaning fee screens alone miss actual client trading costs
• Fund size does not guarantee liquidity: two smart beta ETFs with similar $500+ million assets showed dramatically different trading volumes (4,616 vs 43,271 trades) due to one having 90% concentrated ownership

Summary: 3 ETF Liquidity Myths That Can Raise Client Costs

Key Findings:

State Street Investment Management research challenges three common misconceptions about ETF liquidity that can significantly impact trading costs for advisors and investors.

Myth 1: Lower Expense Ratios Equal Lower Total Costs

State Street's analysis of the 100 largest U.S. equity ETFs found no correlation between expense ratios and bid-ask spreads. A hypothetical example compared two funds with a $10 million position:

• Fund ABC: 0.07% expense ratio, 0.05% spread = 0.12% total cost
• Fund XYZ: 0.10% expense ratio, 0.01% spread = 0.11% total cost

Despite higher fees, Fund XYZ's tighter spreads resulted in $1,500 lower overall costs. The gap widened with larger trades—at $6 million rebalances, XYZ maintained 0.11% costs while ABC climbed to 0.14%.

Myth 2: Short-Term Liquidity Snapshots Tell the Whole Story

Using 2018-2019 data, researchers demonstrated that 30 or 90-day averages can mislead. One fund showed spreads exceeding 0.07% on 34% of trading days despite favorable short-term metrics. Size doesn't guarantee liquidity either—one $520 million smart beta ETF with 90% concentrated ownership logged only 4,616 trades versus 43,271 for a similarly-sized peer, resulting in spreads of 0.14% versus 0.05%.

Myth 3: All ETF Trades Execute the Same Way

Advisors have multiple execution options beyond simple market orders. Limit orders, risk trades through institutional desks, and creation orders priced at NAV offer varying cost structures. Creation fees typically range from hundreds to thousands of dollars per order.

Recommendation: Match liquidity analysis to strategy—emphasize expense ratios for buy-and-hold positions, but prioritize trading costs for high-turnover tactical portfolios.