Exchange-traded funds (ETFs) are known for their simplicity: you can buy or sell them throughout the day, just like a stock. However, behind this apparent ease of use lies one of the most efficient mechanisms in modern investing. Examining how ETFs work helps investors understand why these vehicles, especially when combined with active management, have become an extremely effective way to invest today.
How ETFs really work
The liquidity of ETFs has two dimensions: the liquidity of the secondary market and that of the primary market.
In the secondary market, ETF shares can be bought and sold on stock exchanges such as the London Stock Exchange or Euronext. The liquidity visible on the screen, or in other words, the bid and ask prices, reflect the number of shares traded between buyers and sellers.
Behind the secondary market is the primary market, where specialized institutions known as authorized participants can obtain the issuance or redemption of ETF shares directly from the issuer in exchange for the underlying securities held by the fund. This mechanism ensures that liquidity increases or decreases in line with demand, so that ETF prices remain closely aligned with the fund’s net asset value (NAV).
As a result, even ETFs that do not have high daily trading volumes can be highly liquid if their underlying securities are. This distinction is particularly important for professional investors who want to compare ETFs with mutual funds.
The importance of this mechanism for active ETFs
Active ETFs are based on the same infrastructure as traditional ETFs, but add a crucial element: professional portfolio management. This gives investors access to an easy-to-trade, transparent instrument while benefiting from active oversight and disciplined investment decisions.
Robeco‘s active ETFs combine the best of both worlds, offering the flexibility of an ETF combined with the precision of research-driven active management. Managed under European UCITS regulations, our active ETFs pursue superior risk-adjusted returns over the long term through a combination of robust models, sound economic principles, and human insight. The ETF structure allows us to offer accessible, tradable, and cost-effective strategies, all within the proven European regulatory framework.
The impact of liquidity on ETF prices
ETFs are traded continuously throughout the day and prices are updated in real time. To ensure smooth trading, market makers quote both bid (money) and ask (letter) prices, and the difference between the two – or bid/ask spread – represents the cost of instant liquidity.
In the most liquid ETFs, this spread tends to remain narrow. In the case of less active ETFs, authorized participants can request the issuance or redemption of shares, anchoring the market price to the underlying NAV. Thanks to this dual mechanism, ETFs remain relatively stable even in times of market stress, as observed in European stock markets in recent years.
Transparency and price discovery
ETFs, because they often publish their portfolio positions and are traded on a continuous basis, make an important contribution to price discovery by distilling the consensus of thousands of market participants.
In the case of active ETFs, this transparency highlights both the efficiency of the structure and the accountability of active management. Robeco’s active ETFs, for example, regularly publish their positions and are designed to operate efficiently, so that investors know what they hold and can act with confidence.
Access, efficiency, and evolution
The European ETF market is changing rapidly. Originally created as vehicles for passive exposure, ETFs have become instruments that support a wide variety of investment styles.
Active ETFs offer the same accessibility, liquidity, and affordability as traditional ETFs, but with the added flexibility and strategic insight of active management. This combination is making them increasingly popular with wealth managers, multi-asset managers, and other UK investors seeking to combine agility and accountability.
With the growing depth of trading infrastructure, tighter spreads, greater transparency, and an increase in market makers operating in Europe, active ETFs are becoming an indispensable tool for modern investors.
Conclusions
Despite their apparent simplicity, ETFs are based on a sophisticated trading mechanism carefully designed to promote market liquidity and efficiency. Combined with active management, this mechanism becomes a platform for disciplined innovation that helps investors act decisively, implement effective diversification strategies, and stay aligned with their long-term goals.
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