For example, Vanguard’s ETF Capital Markets Desk gets a lot of calls from advisors about large trade orders to rebalance client portfolios. Rebalancing trades may recur—say, quarterly—or they may be used strategically when markets are volatile. Advisors often ask how they can minimize transaction costs as they rebalance clients’ ETF portfolios to achieve their targeted allocations.

As investors continue to shift to ETFs, larger block trades are hitting the market more frequently.¹ This means that getting the trading piece right is more important than ever.

Just as carpenters have unique tools in their toolbox for specific jobs, investors have different trading strategies at their disposal for different types of transactions. It’s important to choose the tools that will most help you execute your ETF order and incur the lowest transaction costs possible.

Crucially, big and small ETF trades are not necessarily handled the same way. Smaller ETF trades typically use “low-touch” orders, which can be self-provisioned by executing either limit orders or market orders. Larger ETF block trades generally take a “high-touch” approach.² High-touch trades may require working with a custodian’s block trading desk to execute the ETF order with greater discretion.

• Market order: An order to buy or sell a security immediately at the best available current price. The priorities for this type of order are speed and execution, not price. These are popular among individual investors who want to buy or sell ETFs without delay. The primary risk associated with this order type is the impact on price.

• Limit order: An order to buy a security at no more than—or sell a security at no less than—a specified price. This gives the investor some control over the price at which the trade is executed and can safeguard against unexpected market volatility.

• Marketable limit order: A limit order that is placed for immediate execution. For a marketable buy limit order, the limit price is set at or above the ask price—the price at which the security is offered for sale. For a marketable sell limit order, the limit price is set at or below the bid—the price a prospective buyer is willing to pay.

• Risk trade: A trade at a negotiated price for a block of ETF shares, in which the market maker—a dealer firm that maintains specified bid and ask prices and can buy or sell at publicly quoted prices—commits capital to facilitate the investor’s order immediately. Generally, risk trades occur at a slight premium or discount to the quoted spread or national best bid and offer (NBBO) at the time of the trade.

• Algorithmic trades (algos): Trading strategies that use automated algorithms to try to achieve specific execution outcomes. Algo trades are generally executed over time and are intended to minimize price impact in the market. Three common algo strategies are:
  • VWAP trade—Volume-weighted average price, based on a security’s average trading price throughout the day and accounting for trade volume.
  • TWAP trade—Time-weighted average price, based on average trading price for evenly divided time slots to try to minimize market impact.
  • POV trade—Percent of volume, using partial orders based on a user-defined participation ratio and market volume.        

Deciding whether to use low-touch or high-touch orders depends on how big the investor’s planned trade is compared with the ETF’s liquidity profile, or how easily the ETF’s shares can be quickly bought or sold at a price reflecting its intrinsic value. If the trade amount exceeds 5% of the ETF’s average daily volume (ADV), a few other considerations are important before submitting an order. An investor with experience submitting low-touch market orders in this scenario may wish to consider marketable limit orders instead. These are limit orders priced for immediate execution.³

Anyone considering a marketable limit order for a relatively large trade should understand whether enough shares are available in the secondary market to readily absorb the trade. For sellers, the offer should not greatly exceed the shares on the bid; for buyers, the request should not greatly outnumber the shares on the offer. Too large an order could show too much information to the market, which could work against execution quality.

It may still be possible, though, to execute a low-touch trade that is much larger than the quoted size in the secondary market. This would be in the form of a not held limit order. Such orders allow investors to stipulate the price at which they’re willing to execute the trade and protect against unintentional price impact, while not revealing the full size of the trade to the market. If bids or offers don’t materialize at the desired price, the trade won’t happen, thus avoiding any unexpected ETF executions.

The adjacent decision tree can help an investor determine whether a high-touch or low-touch order is most suitable. If the trade size exceeds both 5% of ADV and the quoted size available on the bid/offer, the investor may also need to consider whether the order is large enough to result in the creation or redemption of ETF shares.⁴

Vanguard occasionally sees a trading style applied to ETFs that has traditionally been used for mutual fund portfolios—submitting batch orders all at once at the same time each day.⁵ Although this works for mutual funds priced once a day at the fund’s net asset value (NAV), it may not be the best solution for ETFs. Rebalancing numerous portfolios and submitting countless low-touch trades for a single ETF at the same time runs the risk of affecting the ETF’s price and resulting in higher transaction costs for the end investor.

One useful trading technique that can make rebalancing ETF portfolios across numerous investor accounts more efficient is order aggregation—the simple concept of taking numerous orders on the same ETF and the same side of the market and aggregating them into a single trade.

Not only does this minimize the operational challenges of submitting multiple trades across various investor accounts, but it also provides more trade flexibility in using high-touch orders to help achieve the best execution.

The great benefit of intraday trading should be balanced with the right trading strategy.

As the use of ETFs increases and larger trades become more frequent, investors have an opportunity to perfect how they approach big trades such as rebalancing trades. Investors who weigh different trade considerations carefully to avoid any surprises and achieve the best execution can potentially increase the chances for optimal outcomes.

Using the ETF trading decision tree can help avoid an unexpected ETF execution.

• ETF premiums and discounts, explained (article, issued August 2023)
• Case studies in the cost of ETF ownership (article, issued July 2023)
• Vanguard expands lineup as ETF market grows (Q&A, issued May 2023)