An investment fund that pools investor money to invest in assets. Trades like a stock. Share price is kept near NAV through creation and redemption, which alters share supply.

Differences from Mutual Funds

  • ETFs can be traded during market open, mutual funds only after market close
  • ETF share pricing is determined intraday by market forces so share price can be higher or lower than fund NAV, mutual fund pricing calculated after market close based exclusively on NAV

Creation Process

  1. The AP assembles a portfolio of securities that mirrors the ETF’s underlying index or strategy. This portfolio is known as the “creation basket” or “creation units.” The basket is typically composed of the actual securities held by the ETF or a representative sample. 
  2. The AP delivers the creation basket to the ETF issuer. This transfer is typically done in-kind, meaning the AP exchanges the actual securities for newly created ETF shares instead of cash. 
  3. The ETF issuer creates new shares and delivers them to the AP in the agreed-upon quantity. These newly created shares increase the number of outstanding shares in the ETF. 
  4. The AP may choose to keep the new ETF shares or sell them on the secondary market. If sold on the secondary market, the shares are listed on the stock exchange, allowing individual investors to buy and sell them throughout the trading day. 

Redemption Process 

  1. APs may choose to redeem ETF shares to the ETF issuer. The decision to redeem shares may be driven by factors such as market demand, arbitrage opportunities, or the need to acquire the underlying securities for other investment purposes. 
  2. The AP notifies the ETF issuer of its intent to redeem shares. The ETF issuer provides the AP with a “redemption basket,” specifying the securities that will be received in exchange for the redeemed ETF shares. 
  3. The AP delivers the ETF shares to the ETF issuer, and in return, the AP receives the specified securities in the redemption basket. This process is conducted in-kind to maintain the tax efficiency of the ETF. 
  4. The ETF issuer cancels the redeemed shares, reducing the total number of outstanding shares in the market. 
  5. The AP may choose to hold the securities received in redemption or sell them on the secondary market. If sold on the secondary market, these securities are available for other investors to buy and sell.