Apr 2 2022, 02:45 PM
QUOTE(Hoshiyuu @ Apr 2 2022, 02:10 PM)
Now, market maker try to keep these value as close as possible, to minimize what we call tracking errors.
Or as far as possible, but not until it scares long-term investors away. 
This is what most passive ETF investors who like "low-cost" funds actually miss out. One source of profit for the fund managers like Vanguard and Blackrock has been the spread between the true underlying NAV and the ETF market value.
It's still a very oligopolistic market for the fund management industry, so the tracking errors will sustain for some time until more players come in and bring it down (slightly) due to competition.
QUOTE
Finally, the ETF industry has a strong incentive to promote these products over traditional mutual funds. It is not that their stated fee structures are materially higher than those of open-ended mutual funds, but there are opportunities to trade profitably around the management of fund shares that generate large and steady streams of revenue.
The process can be contrasted to the creation of shares in an open-ended mutual fund. In the traditional fund, the manager receives indication of new investments or redemptions over the course of the day. If there is net flow in it is the managerโs job to buy underlying shares of stock at as close to the final net asset value as possible so that the newly created fund shares match up well with the underlying assets. In general, any improvement in the price at which the underlying stocks are acquired accrues to the benefit of all the other fund participants as the new assets go into the pool at less than the end of day NAV. Net redemptions are simply the mirror image of this process on the sell side.
New ETF shares are created whenever the market demand exceeds the existing supply available for sale. At such times an Authorized Participant (AP) goes about acquiring the underlying stocks in the ETF and packaging them into new ETF shares. The shares are registered with the sponsor and become part of the float. Again, the process of redeeming shares is identical on the other side.
The key distinction, however, is that the AP does not act until there is some indication of excess demand for the ETF shares. That indication is the price of the ETF rising above the NAV of the underlying shares. This is an activity that gives rise to an arbitrage opportunity for the AP. Once the ETF price is high enough, the AP buys the lower priced securities and sells the new shares of the ETF, locking in a trading profit.
This activity is essentially the same kind of arbitrage that has gone on between stock index futures and baskets of stocks since the 1980s. In the case of stock index arbitrage-using futures, it is a highly competitive open market and long ago any excess profits were competed out of the system. It is somewhat different with ETFs. While there are many authorized participants operating across literally hundreds of ETFs, there is not complete and open competition for these services. The arbitrage spreads are not egregiously large, but they are attractive enough to encourage institutional ETF participants to promote more business.
This brings us to where we are today. The ETF market has grown to become a major force in all major equity markets around the world, with steadily expanding volumes. The lionโs share of the business is concentrated in a relatively small number of major index ETFs, but new entries appear regularly. Each of the new products is trying to reach critical mass that will support the operations of the ETF and the trading opportunities of the associated authorized participants. Few people know before the fact which of the new products will become blockbusters, or in fact have any success at all. But the economics of the marketplace are such that there are many incentives to continue to create new products. Fortunately for investors the benefits of ETFs are attractive enough to justify the different layers of modest cost. It is debatable whether anyone really needs equity ETFs given the vast array of other alternatives available, but it seems without question that they are a product that is here to stay
The process can be contrasted to the creation of shares in an open-ended mutual fund. In the traditional fund, the manager receives indication of new investments or redemptions over the course of the day. If there is net flow in it is the managerโs job to buy underlying shares of stock at as close to the final net asset value as possible so that the newly created fund shares match up well with the underlying assets. In general, any improvement in the price at which the underlying stocks are acquired accrues to the benefit of all the other fund participants as the new assets go into the pool at less than the end of day NAV. Net redemptions are simply the mirror image of this process on the sell side.
New ETF shares are created whenever the market demand exceeds the existing supply available for sale. At such times an Authorized Participant (AP) goes about acquiring the underlying stocks in the ETF and packaging them into new ETF shares. The shares are registered with the sponsor and become part of the float. Again, the process of redeeming shares is identical on the other side.
The key distinction, however, is that the AP does not act until there is some indication of excess demand for the ETF shares. That indication is the price of the ETF rising above the NAV of the underlying shares. This is an activity that gives rise to an arbitrage opportunity for the AP. Once the ETF price is high enough, the AP buys the lower priced securities and sells the new shares of the ETF, locking in a trading profit.
This activity is essentially the same kind of arbitrage that has gone on between stock index futures and baskets of stocks since the 1980s. In the case of stock index arbitrage-using futures, it is a highly competitive open market and long ago any excess profits were competed out of the system. It is somewhat different with ETFs. While there are many authorized participants operating across literally hundreds of ETFs, there is not complete and open competition for these services. The arbitrage spreads are not egregiously large, but they are attractive enough to encourage institutional ETF participants to promote more business.
This brings us to where we are today. The ETF market has grown to become a major force in all major equity markets around the world, with steadily expanding volumes. The lionโs share of the business is concentrated in a relatively small number of major index ETFs, but new entries appear regularly. Each of the new products is trying to reach critical mass that will support the operations of the ETF and the trading opportunities of the associated authorized participants. Few people know before the fact which of the new products will become blockbusters, or in fact have any success at all. But the economics of the marketplace are such that there are many incentives to continue to create new products. Fortunately for investors the benefits of ETFs are attractive enough to justify the different layers of modest cost. It is debatable whether anyone really needs equity ETFs given the vast array of other alternatives available, but it seems without question that they are a product that is here to stay
Page 388-389, from this book: https://forum.lowyat.net/index.php?showtopi...ost&p=103481709
This post has been edited by TOS: Apr 2 2022, 02:45 PM
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