ETFs: Behind the Scenes

January 8th at 3:36pm by Tom Lydon

Unlike traditional and active mutual funds, exchange traded funds have a simple elegance that allow investors to efficiently capture a specific or broad market segment.

When managing an ETF, providers keep their funds’ holdings and value of the holdings in line with the indices that they try to mimic, reports Ari I. Weinberg for the Wall Street Journal.

“It’s pretty simple, really,” Hao-Hung (Peter) Liao, Portfolio Manager for Van Eck’s Market Vectors ETFs, said in the article.

The ETF vehicle requires less hands, compared to their index and actively managed mutual fund counterparts. A single manager or small team can oversee a large number of ETFs. For example, 87% of Van Eck’s ETF assets are tied to the 38 funds managed by Liao and a staff of three portfolio managers and analysts.

Instead of buying or selling the underlying securities to meet orders, authorized participants, or market makers, and brokers to facilitate trades. [How to Effectively Execute ETF Trades]

Authorized participants are the people behind the scenes that make sure the value of the ETF is in line with its net asset value. They would receive ETF shares in exchange for a basket of underlying securities or receive a basket of underlying securities when they redeem ETF shares. When there is a premium or discount in the ETF, authorized participants step in to capitalize on the arbitrage opportunities.

Furthermore, a fund provider may also have to dip into foreign markets as a way to help redeem or create new ETF shares for an internationally focused fund.

Besides the market aspect, fund providers also have to monitor changes in the underlying holdings that could affect an ETF’s weighting. For instance, managers will have to check on corporate actions, which include mergers and spin-offs, and index rebalancing or reconstitution. Additionally, for international ETFs, they will have to track overseas orders and place trades with international brokers. [How to Use ETFs in a Trend-Following Strategy]

For more information on ETFs, visit our ETF 101 category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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