Author Topic: Liquidity of Smaller Holdings in VTSAX  (Read 1327 times)

LuckyOwl

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Liquidity of Smaller Holdings in VTSAX
« on: July 29, 2016, 01:09:42 PM »
Looking at the holdings in VTSAX... Apple tops the list of course, but at the other end are companies most people have never heard of (Hovnanian Enterprises Inc. Class B for example).

When we buy a share of VTSAX, how can there possibly be enough liquidity at the lower end of the holding scale to ensure that the trade can be fulfilled? Obviously there are going to be shares of Apple and Exxon available pretty much any time, but what about shares of Allen Organ Co. Escrow Shares?

It seems unlikely ,and, probably not feasible, to have to buy shares (or portions of a share) each time someone submits a buy order for VTSAX or VTI. Is there another way Vanguard approximates the performance of the entire index without actually holding shares of every company?
« Last Edit: July 29, 2016, 01:40:45 PM by LuckyOwl »

seattlecyclone

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Re: Liquidity of Smaller Holdings in VTSAX
« Reply #1 on: July 29, 2016, 09:54:00 PM »
They do actually buy all the stocks. I would guess that they buy the smaller companies a bit less often, wait until they have some minimum dollar amount they need to buy before they actually make a trade.

Radagast

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Re: Liquidity of Smaller Holdings in VTSAX
« Reply #2 on: July 29, 2016, 10:35:04 PM »
I am not a super expert on this, I just skimmed a few descriptions on ETF.com once. There are things called "creation units" which Vanguard will not create or dissolve until there is enough demand for the entire thing. Thus it does not perfectly track the index on an hourly basis, or even necessarily over longer periods. There are a lot more people than Vanguard involved, brokers and market makers and such. I think there may be "authorized participants" or something who can make their own creation units.

Heckler

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Re: Liquidity of Smaller Holdings in VTSAX
« Reply #3 on: July 30, 2016, 09:12:58 AM »
Theres lots of reading to be had.  Heres one article.  Sorry I didnt find the specific answer to your Q, but knowledge is power.  The Correlation bit (3rd article in the series) was hinting to your small cap question.

https://www.thestreet.com/story/11642406/1/what-is-an-etf-an-introduction.html
« Last Edit: July 30, 2016, 09:18:12 AM by Heckler »

Heckler

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Re: Liquidity of Smaller Holdings in VTSAX
« Reply #4 on: July 30, 2016, 09:20:15 AM »
The funny part to me is that several higher fee mutual funds I've seen simply hold diversified ETFs for you. 

MustacheAndaHalf

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Re: Liquidity of Smaller Holdings in VTSAX
« Reply #5 on: July 30, 2016, 12:07:23 PM »
My understanding is that Vanguard uses derivatives to both be fully invested and have a cash reserve.  When you sell your shares, you get paid from the cash reserve.  When you send the mutual fund money, that cash goes into their cash account.

I would guess Vanguard buys a "call" option on the underlying index.  When there's more cash than stock exposure, Vanguard buys a call with some of the cash position, which is a leveraged way of becoming 100% invested again.  This is not leverage to make more money - it's leverage exactly proportional to the fund's cash position.  It keeps the fund fully invested.

Over time, sometimes stocks are cheaper than options.  So Vanguard probably waits for those opportunities, and then shrinks it's cash position by purchasing underlying securities.  That ensures incoming funds remain fully invested, and that it doesn't spend too much of it's assets on options.

Note the ETF and creation units are a little different - demand pushes the price up, which causes third parties to want to make a profit on the excess demand.  They essentially sell blocks of stock to the ETF, because the block of stock is cheaper than the ETF.  And then the ETF accepts a creation unit block of stock.  One complexity is that Vanguard has some way of mixing ETF and mutual funds that involves a patent.  So the situation might differ in some details at Vanguard.