What Is an ETF Sponsor?
An exchange-traded fund is a type of security that tracks an index, sector, commodity, or other assets, but which can be purchased or sold on a stock exchange the same as a regular stock. An ETF can be structured to track anything from the price of an individual commodity to a large and diverse collection of securities. ETFs can even be structured to track specific investment strategies.
- An ETF sponsor is a financial firm that issues, manages, and markets an exchange-traded fund.
- ETF sponsors handle the creation and redemptions of ETF shares, known as units.
- The ETF sponsor does not usually enter into trades directly with other market participants on the open market.
An Introduction To Exchange-Traded Funds (ETFs)
Understanding ETF Sponsors
An ETF sponsor manages an exchange-traded fund. A group of institutional investors supplies the securities that will make up the fund, and in exchange for this delivery, gain so-called creation units, which are ETF shares in giant blocks, numbering 100,000 or more shares.
The ETF was first introduced in the early 1990s. Since then, ETF sponsors have developed a large industry. A larger, more diversified ETF sponsor may hold an in-house portion of a fund's securities. Others focus on index maintenance, market liquidity, and general marketing. Changes will need to be made to an ETF portfolio when an underlying index is reconstituted, and so at that time, the ETF sponsor works with holders of creation units to do the work of exchanging securities according to those reconstituted index alterations.
The ETF sponsor generally deals only with the creation units and the institutional shareholders; they do not directly trade shares with investors. The ETF sponsor can also redeem physical securities for creation units at an institutional shareholder’s request.
An ETF sponsor may also help design or establish the base index or benchmark that will assist the management of the ETF.
How ETF Sponsors Work With Other ETF Participants
In the primary market, ETF sponsors work with creation-unit holders, or participating dealers (PDs), institutional investors like brokerage houses authorized to create ETFs. There are market makers that may also function as PDs but provide market liquidity. PDs apply to ETF sponsors for a creation unit, thereby creating ETF shares through their purchase from a sponsor, which can come in the form of cash or an in-kind transfer, otherwise known as a securities basket.
PDs may also apply to redeem creation units from a sponsor, receiving a securities basket or cash in return. This process of PDs creating and redeeming with an ETF sponsor provides liquidity to investors who want to make sizable ETF trades.
It is in the secondary market, the stock exchange, where we see the differences in ETFs' functionality compared to mutual funds: ETFs can be sold by PDs to investors through the stock exchange. The ETF sponsor calculates and publishes the net asset value (NAV) daily, which may be more or less than the secondary-market price of the ETF.
Market makers also facilitate trades in the secondary market, providing liquidity and ensuring that there is a bid-offer spread. As a result, the price of ETF shares changes in real-time on exchanges. By contrast, mutual funds establish their daily NAV after trading ends for a given day.