As illustrated in Figure 2, when demand for the ETF shares exceeds supply, a creation ensures there is sufficient inventory to fill an investor’s order. In ETF share creation, a firm authorized to purchase securities to create more ETF shares—known as an authorized participant (AP)—assembles a portfolio (or “basket”) containing the ETF’s current holdings. The authorized participant turns over the basket to the ETF custodian, who is responsible for holding it. In return, the custodian delivers ETF shares that can then be bought and sold in secondary markets, generally in blocks of 50,000 or 100,000 shares.
ETF share redemption reverses this process when the excess supply of ETF shares needs to be removed from the marketplace. The creation and redemption process helps keep supply and demand in balance, leading to an ETF share price that is generally in line with the value of the underlying securities.
Trading Tips and Tactics
There are a few simple steps that can give investors greater confidence in placing ETF trades (see Figure 3). While there are no hard-and-fast rules that apply under all circumstances, different situations and investor objectives call for differing tactics. No one approach is best in all situations, so it’s important to understand the potential benefits and limitations of each and choose the one that best fits the specific circumstance.
Call On ETF Capital Markets
ETF capital markets experts at issuers and broker/dealers are available to guide you through your ETF trading strategies, help bring about a positive trading experience, and achieve the best execution to help meet trading objectives.
Matt Lewis is vice president, head of ETF implementation and capital markets at American Century Investments.