Comment by borism | Hacker News Reader

Comment by borism | Hacker News Reader

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1. read the prospectus. if the fund is comprised of stocks as opposed to derivatives it will be comprised of stocks. Of course fund will only buy whole and large amounts of shares, so say you put 1 ETF share worth $100, the fund won't be hurrying to buy shares with it, until they got $1000000 to start buying wholesale.

2. Of course if fund is derivative based all risks associated with derivatives come into play for fund investors. Same is true for any securities that are owned by funds - their risk is transferred to shares of fund. But I think you're familiar with risks associated with equity investing.

3. Maybe, maybe not, depends on stocks and market conditions. Of course the company is "more valuable" if it's included in some popular index like S&P, but then again ETF's and funds can make purchases wholesale, so there might be some benefit too.

4. Yes, but since traditional non-derivatives based funds are linked 1-to-1 to underlying shares, I don't see a huge problem. Unlike with derivatives-based funds.

Of course fund will only buy whole and large amounts of shares, so say you put 1 ETF share worth $100, the fund won't be hurrying to buy shares with it, until they got $1000000 to start buying wholesale.

The ETF will actually never buy the shares. You can only buy existing ETF shares from other traders.

ETF shares are created by large financial institutions - JPM/GS/other big players have the option to make an in-kind trades of share in securities for ETF shares. I.e., if an ETF is 50% MS and 50% AAPL, a large trader can trade 50k shares of AAPL and 50k shares of MS for 100k shares of the ETF. (Similarly, they can perform the reverse trade.)

I don't quite understand what you're saying.

From what I understand when the ETF achieves cash position needed to generate 1 creation unit (usually 50k ETF shares, as you correctly point out), then the fund is absolutely required to purchase underlying shares that index it's tracking requires it to hold. It can't just hold cash and promise to track index nevertheless. Or do you mean that first comes the Creation Unit, and then people can buy shares in ETF?

In case of ETN there's absolutely no obligation to purchase anything, as they're simply debt of issuer; a promise to repay you in the future according to predetermined index or underlying movement.

Maybe you meant ETNs?

P.S. I re-read what you wrote, and I think what you're saying is that large institutions are intermediaries between ETF and investor. That is absolutely correct, and probably is so 99% of the time in the market anyway regardless of whether shares purchased are of individual companies or funds. But ETF is still required to hold the assets it states it will hold, that was my point.

You don't trade cash for the creation unit, you trade one creation unit of shares in the underlying securities. If 1 share of AMSETF is claimed to be equal to 0.5 shares in AAPL and 0.5 shares in MS, you hand 50k shares of AAPL and 50k shares of MS to the managers of AMSETF. They create 50k shares of AMSETF and hand them to you.

No cash changes hands (unless cash is one of the underlying assets of the ETF), so the ETF is never sitting on cash with the obligation to purchase shares.

In general, it's very unusual to hand cash to an ETF in return for shares (unless cash is one of the underlying assets). I'm not even sure it is legal to do so.

okay, I was sloppy in my description of ETF mechanics.

but from investor point of view it still works as I described - she goes to market, places bid for ETF shares. Then the process splits as following:

a) if there are sellers in the market she gets her shares from them b) if there are no sellers, market makers will still sell her the ETF shares

then once market maker accumulates enough cash from buyers, he purchases/borrows shares needed for exchange for N creation units from ETF trust.

I don't think market makers just go and create ETF shares without there first being demand for them?

It sounds like you are expecting the ETF would be creating more shares frequently which it does not. That would have to happen as a secondary offering and it would dilute the value of all the other shares in circulation, Assuming they are the same class share.

There's no dilution with ETF. When ETF shares are created (via formation of Creation Unit), the ETF holdings increase by equal amount of underlying assets. You can create as many ETF shares as market demands (until you run out of possibility to buy underlying assets).

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