Hello Andy,
In order to understand how an ETF works, you need to understand the similarities and the differences between an ETF and a mutual fund.
To answer your question, yes you are right. The creation and redemption of ETF shares sit on the primary market space. During the ETF share creation process, the Authorised Participant (AP) will buy the underlying assets of the ETF and they will exchange for the ETF shares with the ETF provider. The AP will then unload these ETF shares into the secondary market. As for the redemption of ETF shares, it will be the opposite. If this process is missing, you and I cannot buy ETF shares on the exchange in the first place, and there will not have any mispricing.
The main purpose of the ETF creation and redemption is to restore the price back to its Net Asset Value (NAV). To put the creation and redemption process into perspective, let's take STI as a simple example. On a given trading day, the AP, usually a bank, will know the its true NAV of the STI base on the valuation of ETF model. Assuming the NAV is $100, and the STI ETF is trading at a premium on SGX say $105, the bank can make a riskless profit otherwise known as arbitrage by unloading more shares into the secondary market. The price you see on SGX is determine by market force (i.e demand supply), and that is not the "real" value of the STI. To drive the STI ETF price down, the AP will go to the exchange to buy all the underlying STI securities, in this case will be 30 companies, and exchange all these individual shares (and cash) for the STI ETF shares with the STI ETF provider (Nikko AM). Once the AP receives the ETF shares from Nikko, the AP will then sell these shares to the (retail) investors on an exchange. Since there are more supply of ETF shares now, this will drive the prices down back to the equilibrium. From the (retail) investor view point, we will go to our broker to buy the ETF shares, and the broker will get these ETF shares from SGX.
To just summarise, there are 3 prices to paint: STI Index, STI NAV, the STI ETF stock price on an exchange. All in all, the ETF provider is trying their best to match their NAV towards the benchmark (STI Index). There will always be a difference between the NAV and the STI index, and this difference is also known as the tracking error.
Hope that helps to answer your question.
Hello Andy,
In order to understand how an ETF works, you need to understand the similarities and the differences between an ETF and a mutual fund.
To answer your question, yes you are right. The creation and redemption of ETF shares sit on the primary market space. During the ETF share creation process, the Authorised Participant (AP) will buy the underlying assets of the ETF and they will exchange for the ETF shares with the ETF provider. The AP will then unload these ETF shares into the secondary market. As for the redemption of ETF shares, it will be the opposite. If this process is missing, you and I cannot buy ETF shares on the exchange in the first place, and there will not have any mispricing.
The main purpose of the ETF creation and redemption is to restore the price back to its Net Asset Value (NAV). To put the creation and redemption process into perspective, let's take STI as a simple example. On a given trading day, the AP, usually a bank, will know the its true NAV of the STI base on the valuation of ETF model. Assuming the NAV is $100, and the STI ETF is trading at a premium on SGX say $105, the bank can make a riskless profit otherwise known as arbitrage by unloading more shares into the secondary market. The price you see on SGX is determine by market force (i.e demand supply), and that is not the "real" value of the STI. To drive the STI ETF price down, the AP will go to the exchange to buy all the underlying STI securities, in this case will be 30 companies, and exchange all these individual shares (and cash) for the STI ETF shares with the STI ETF provider (Nikko AM). Once the AP receives the ETF shares from Nikko, the AP will then sell these shares to the (retail) investors on an exchange. Since there are more supply of ETF shares now, this will drive the prices down back to the equilibrium. From the (retail) investor view point, we will go to our broker to buy the ETF shares, and the broker will get these ETF shares from SGX.
To just summarise, there are 3 prices to paint: STI Index, STI NAV, the STI ETF stock price on an exchange. All in all, the ETF provider is trying their best to match their NAV towards the benchmark (STI Index). There will always be a difference between the NAV and the STI index, and this difference is also known as the tracking error.
Hope that helps to answer your question.