Is It Really Difficult to Sell an ETF with Very Low Trading Volumes?

The doubt

Recently, I was looking at the Mirae Asset Nifty 500 Value 50 ETF. As a value investor, the idea of this ETF appeals to me. It holds 50 value stocks from the Nifty 500 universe. It has a low cost with no fund manager bias.

But one doubt came to my mind. The trading volume of this ETF is quite low.

So, if I buy it today, will I be able to sell it easily tomorrow? Or will I get stuck, like it sometimes happens with micro-cap stocks?

I think many of us have this fear, right?

So let me share what I understood about the low trading volumes of Exchange Traded Funds (ETFs).

How thin is the volume?

This Mirae Asset Nifty Value ETF trades on both exchanges, NSE and BSE.

Its average daily volume is around 52,000 units. The current price of this ETF is around ₹16 per unit. So, on a normal day, roughly ₹8 lakh worth of units change hands.

Compare this with a large ETF like a Nifty 50 ETF, where crores are traded daily.

So yes, this value ETF’s trading volume is really thin, and this was the root of my doubt. When I look only at this number, the fear looks justified.

₹8 lakh a day is similar to what many micro-cap stocks trade.

But there was an important point related to ETFs that I was missing. Volume alone does not tell the full story for an ETF.

Why an ETF is different

When I sell an ETF, my buyer need not be only another investor like me.

The fund house appoints some brokers called market makers. Their job is to keep quoting buy and sell prices on the exchange throughout the day. So even if no ordinary investor wants my units that day, the market maker will usually buy them.

Why will they buy? How will they sell these units? There is a special provision made for them. They are never stuck with those units.

Once they collect enough units, they can return them to the fund house. In exchange, the fund house gives them the actual 50 stocks that the ETF holds. These are Nifty 500 stocks, which trade in good volumes every day. So the market maker can easily sell these collected stocks in the market and get their money back.

This is also why the ETF price stays close to the real value of its holdings, which is called NAV.

If the price falls too much below NAV, the market maker sees a profit opportunity. They buy the cheap units, redeem them, sell the stocks, and pocket the difference.

This buying pulls the price back up.

In simple words, the liquidity of an ETF comes from the stocks inside it, not only from its own trading volume.

Why a micro-cap stock’s trading volume is different from an ETF’s

A micro-cap stock has no such backstop.

Unlike ETFs, there is no market maker who is bound to buy. There is no fund house where I can exchange my shares for something more liquid.

If nobody wants to buy a micro-cap stock, it means there is simply nobody to sell to.

Many of us have seen this in a falling market. A small stock hits the lower circuit, and there are only sellers in the order book. One can sit there for days, watching the price fall, and still not get out.

To sell, I may have to drop my price sharply to attract a buyer. Sometimes even that does not work.

So the two risks are not the same. With a thin ETF, the worst case is usually a slightly worse price. With a micro-cap, the worst case can be getting stuck.

The real risk, and how I would sell

This does not mean a thin ETF is risk-free to sell.

The risk is not that I cannot sell. The risk is that I sell at a bad price.

In low-volume ETFs, the gap between the buy price and the sell price can be wide. Sometimes the ETF also trades at a discount to its iNAV, which is the live value of its holdings during market hours.

If I place a market order, I may end up selling a few percent below the true value.

So, this is how I would approach it:

1. Check the iNAV before selling. Most AMC websites and NSE show it.
2. Use a limit order, priced close to the iNAV. Avoid market orders.
3. Sell during normal market hours. Avoid the first and last 15 minutes, when spreads are usually wider.
4. Split the sale over a few days if the order value is large.

These small steps take care of most of the problem.

Conclusion

So, is it difficult to sell the Mirae Asset Value ETF? A little, yes. But it is not as difficult as selling a micro-cap stock.

The two look similar on the volume chart, but the mechanism behind them is very different.

For me, low volume in an ETF is a reason to be careful while placing the order. It is not a reason to avoid the ETF altogether.

What matters more is whether the strategy behind it, in this case, value investing, fits my thinking.

And yes, one small piece of advice.

Before buying any thin ETF, check its bid-ask spread on two or three different days. If the gap is consistently small, you have your answer. If the gap is consistently small, it means you’ll be able to sell close to its fair value, despite the low volume.

Happy Investing.