Part 2
How do ETFs work?
So firstly, an ETF company will decide to create a new fund with a specified goal. Securities are purchased in the relevant area in line with the specified purpose, and then they are exchanged for blocks of the shares in the new ETF, which are equal in value. This is referred to as an “in-kind transfer.” These blocks of shares are called the creation units. The size of these can vary considerably based on volume and demand. These are then sold to market makers and investors on an exchange. The secondary market between investors then develops.
Source: WisdomTree
So, you can see the management of ETFs isn’t trying to select assets that will outperform the market like in active management. You’re not trying to beat the price of gold. You’re trying to be the price of gold. Do you see the distinction? Many investors want to access tax benefits, diversification, and access to assets not otherwise available.
This is why this innovation has revolutionized finance, and it is hard to argue that they didn’t make markets significantly better. They have also empowered retail investors to a degree by giving them more equal assets that were previously only available to accredited investors or institutions.
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