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INVESTING ETFS
An Inside Look at ETF Construction
BY LISA SMITH Updated Jan 29, 2018
Some people are happy to simply use a range of devices like wristwatches and computers, and trust that things will work out. Others want to know the inner workings of the technology they use, and understand how it was built. If you fall into the latter category and as an investor have an interest in the benefits that exchange-traded funds (ETFs) offer, you'll definitely be interested in the story behind their construction.
How an ETF is Created
An ETF has many advantages over a mutual fund, including costs and taxes. The creation and redemption process for ETF shares is almost the exact opposite of that for mutual fund shares. When investing in mutual funds, investors send cash to the fund company, which then uses that cash to purchase securities and, in turn, issues additional shares of the fund. When investors wish to redeem their mutual fund shares, they are returned to the mutual fund company in exchange for cash. Creating an ETF, however, does not involve cash.
The process begins when a prospective ETF manager (known as a sponsor) files a plan with the U.S. Securities and Exchange Commission to create an ETF. Once the plan is approved, the sponsor forms an agreement with an authorized participant, generally a market maker, specialist or large institutional investor, who is empowered to create or redeem ETF shares. (In some cases, the authorized participant and the sponsor are the same.)
https://www.investopedia.com/articles/mutualfund/05/062705.asp
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