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FOR HOME OFFICE AND ADVISOR USE ONLY – NOT FOR USE WITH THE INVESTING PUBLIC. © 2024 Envestnet | PMC. All rights reserved. To best understand the features of ETFs, it's important to explore how their shares are created and redeemed. In the first post of this series, we investigated the potential advantages of ETFs and how they may benefit investors. In this article, we're going to get a little nerdy as we examine the ETF structure and the innovative process behind ETF trading. Now you may be wondering, "Why should I care how this financial 'sausage' is made?" Well, we think you'll be better able to consider ETFs for client portfolios once you're familiar with their nuts and bolts. So, consider this post to be like a general ETF instruction manual. Time to buckle up! The Crucial Role of Authorized Participants (APs) Authorized Participants (commonly abbreviated "APs") collectively represent an important cog in the ETF ecosystem, and they are typically large broker-dealers or market makers with large inventories of securities. The APs form agreements with an ETF sponsor (the company that creates the ETF and manages it) to convert baskets of securities into ETF shares or to break down ETF shares into their components: individual securities. The ETF sponsor designs the fund's portfolio using various stocks, bonds, and derivatives, and the APs create or redeem ETF shares according to the sponsor's blueprint. A-Tisket, A-Tasket, An ETF Security Basket When money is flowing into an ETF, creation baskets of securities are used to "manufacture" more ETF shares. If money funnels out of the ETF, the APs destroy shares of the fund by chopping them up into redemption baskets of securities. Investor demand for the ETF determines whether more of its shares are constructed or demolished. The security baskets can be thought of as ETF building blocks (or salvaged parts) in this process. FREQUENTLY ASKED QUESTIONS The Nuts and Bolts of ETFs