Exchange traded funds help advisors and investors gain exposure to broad areas of the market or focused segments through an easy-to-use investment vehicle. However, people should understand how their ETFs are traded.
Specifically, ETFs trade in two distinct markets: the secondary markets that everyone typically monitors on a stock exchange and the primary market where specific authorized participants help create and redeem ETF shares, writes Grant Englebart, portfolio manager at CLS Investments, for InvestmentNews.
Everyone should be familiar with the secondary market as it refers to the on-screen, quotable market that we track through price changes on the stock exchange, similar to tracking a company’s stock.
However, ETFs are also traded on a primary market where APs and the ETF sponsor help create and redeem ETF shares for underlying securities or holdings, which occur at the net asset value of the ETF, through so-called in-kind transactions.
The creation and redemption process helps keep an ETF trading near its NAV and allows large traders to go in and out of what appears to be an ETF with low liquidity. For instance, if an advisor or investor is interested in taking large order on an ETF that only trades on a couple thousand shares per day, he or she would contact a broker or authorized participant. The AP would come back with a quote and the investor would pay the broker the necessary commission.