In a world awash with data, exchange traded product (ETP) investors should look at five key metrics when assessing market quality. Together, the following metrics can help investors evaluate an ETP’s ability to offer liquidity, price discovery and efficient access to markets in all market conditions.

1. Usage

ETPs have evolved from buy and hold tools to financial instruments that investors use to trade the market. In fact, we tend to see investors increasingly turning to ETFs to allocate capital and transfer risk in times of market stress.  ETP trading volumes are important because increased liquidity can create a network effect. The most heavily traded ETPs are typically the cheapest to trade, which spurs even more usage.  For this reason, the liquidity of an ETP is a key component of market quality.

2. Trading costs

When the cost of trading of an ETP, measured by its bid-ask spread, is tighter than that of the ETP’s underlying holdings, or exhibits less sensitivity to stressed market conditions, it is a potential signal of high market quality. In these instances, the ETP may facilitate cheaper access to the markets than its underlying securities—and cost-efficient access to markets is another element of ETP market quality.

3. Premium/discounts behavior

An ETP’s tight alignment to NAV can be evidence of a high-functioning arbitrage mechanism, while ETP premiums and discounts in illiquid or volatile markets can indicate an ETF is providing price discovery—both signals of market quality.

4. Tracking

Tracking difference and tracking volatility reflect a fund’s ability to deliver returns that are consistent with the returns of its benchmark, as well as its ability to closely replicate benchmark performance consistently over time. An index ETP with high market quality should deliver this consistency in all market conditions.

5. Primary market efficiency

A diverse set of authorized participants and a stable platform are crucial for an ETP’s primary market operations to be efficient. These enable a platform to handle increased trading volume and can have a direct impact on an ETP’s premium/discount behavior, both of which can provide insight into the ETP’s market quality.

Primary market efficiency is at the heart of ETP market quality

Target displaying five metrics