On the left, Fabiana Perobelli (B3). In the middle, Paulo Dafonseca (BTG). On the right, Pietro Almeida (UBS),
Investors who assess an ETF solely by its trading volume may underestimate its effective execution capacity. During the panel moderated by Fabiana Perobelli of B3, Paulo Dafonseca said the main indicator of liquidity is not the ETF’s daily turnover, but the depth of the assets in its underlying basket.
According to Dafonseca, the market maker considers the weight, bid and ask prices, spread and available quantity of each component when calculating its quotes. Because these positions can be hedged or adjusted through the primary market, the amount visible in the order book does not necessarily represent all the liquidity that can be provided.
Pietro Almeida reinforced the point that an ETF with low daily volume may support a substantially larger transaction if its underlying assets are liquid. Almeida said the volume displayed on screen is relevant, but should not be used as the only measure of the product’s trading capacity.
Creation and redemption support liquidity provision
Dafonseca explained that the creation and redemption mechanism connects the ETF shares traded on the exchange to the assets in the portfolio. This structure allows the market maker to reduce or adjust positions through the primary market, lowering inventory costs and facilitating the replenishment of quotes.
Under an in-kind model, assets from the basket are delivered to create ETF shares or received during redemption. Under an in-cash model, the transaction is completed with cash. Dafonseca noted that the applicable structure depends on the rules of each ETF.
Almeida added that a market maker does not necessarily need to own the ETF shares before offering them for sale. Depending on the product, the institution may sell the shares and subsequently recycle the position through the primary market. This process expands execution capacity without requiring permanent inventory.
Illiquid assets continue to impose limits
Market makers cannot eliminate restrictions arising from the underlying assets. Dafonseca warned that a highly concentrated and illiquid position will affect the ETF’s trading conditions. If an important component enters an auction or trading is halted, the market maker’s pricing and hedging capacity will also be affected.
Almeida said technology, alternative instruments and specialized teams can help mitigate these limitations. According to the UBS representative, market making in Brazil has become increasingly professional, with dedicated teams operating within major financial institutions.
Dafonseca emphasized, however, that no mechanism can completely remove the constraints of the underlying basket. A market maker can facilitate access to existing liquidity and reduce instability in the quotes, but final execution capacity remains dependent on the ability to trade or hedge the portfolio components.
Larger orders require an execution strategy
For larger transactions, Dafonseca recommended caution when using market orders. A large order may move through several levels of the order book and result in an average execution price that is worse than the price initially displayed. Alternatives include limit orders and dividing the transaction into smaller amounts throughout the session.
Almeida recommended that investors and financial advisers contact the market maker or the ETF manager before executing larger blocks. The identity of the market maker is publicly available, and brokerage firms can facilitate contact to assess market depth and organize the transaction.
Dafonseca added that the quantity displayed in the order book may be replenished as quotes are executed. An order should therefore not be planned solely on the number of ETF shares visible at a particular moment.
Transparency guides price formation
Almeida highlighted that an ETF provides an objective pricing reference because its portfolio is known and can be monitored throughout the trading session. The market maker uses the value of the underlying components to continuously update bid and ask quotes.
According to Almeida, this process differentiates ETFs from individual stocks and real estate investment funds. In those assets, prices may depend on valuations and information that are not continuously reflected on screen. For an ETF, the basket and primary-market mechanism provide additional references that help keep the share price close to net asset value.
Fabiana Perobelli concluded that the market maker serves as a mechanism for both liquidity and transparency. The panel’s central conclusion was that ETF liquidity should be assessed through three combined dimensions: visible trading volume, the depth of the underlying assets and the market maker’s operational capacity.
