Understanding ETF (Exchange Traded Fund)
Often we hear or read about ETF or Exchange Traded Fund on news websites. ETFs, or exchange-traded funds, are security assets that can be marketed by tracking indexes, commodities, bonds, or a basket of assets such as index funds. Unlike mutual funds, ETFs are traded like ordinary shares on the stock exchange. ETFs experience price changes throughout the day as they are bought and sold. ETFs typically have higher daily liquidity and lower costs than mutual fund shares, making it an attractive alternative for individual investors.
Because of trades such as stocks, ETFs have no net asset value (NAB) calculated once at the end of the day such as mutual funds.
ETF is a type of fund that has underlying assets (stocks, bonds, futures oil, gold bullion, foreign currency, etc.) and divides the ownership of the asset into shares. The actual structure of an investment vehicle (such as a firm or investment trust) will vary across countries, and within one country there may be multiple structures side by side. The shareholder does not directly own or have a direct claim on the underlying investment of the fund; Instead they indirectly own this asset.
ETF shareholders are entitled to a proportion of the profits, such as interest received or dividends paid, and they may earn residual value if the fund is liquidated. Ownership of funds can be easily purchased, sold or transferred equally to stocks, as ETF shares are traded on the public stock market.
Creation and Redemption of ETF
ETF stock supply is regulated through a mechanism known as creation and redemption. The creation / redemption process involves several large specialized investors, known as authorized participants (APs). AP is a large financial institution with a high level of purchasing power, such as a market maker that may be a bank or investment company. Only AP can create or redeem an ETF unit. As the creation progresses, an AP collects the necessary asset portfolio and converts the basket into funds for a newly created ETF share exchange. Similarly, for disbursement, the AP returns ETF shares into the fund and receives a basket consisting of the underlying portfolio. Every day, the ownership of such funds is disclosed to the public.