9 – L2 08 Authorized Participant And The Create Process V4

Now, here’s where ETFs start to look different from mutual funds. Recall that with mutual funds, investors give their cash to a mutual fund and the mutual fund then invest that cash in a portfolio of stocks. With ETFs, the ETF sponsor only makes transactions with special partners called authorized participants or APs for short. Major APs include Merrill Lynch, Morgan Stanley, Goldman Sachs and Fortis Bank. An AP goes to the stock market and buys stocks that match the portfolio defined by the ETF sponsor. Then, the AP makes a trade with the sponsor. The sponsor creates ETF shares and gives those shares to the AP in exchange for the bundle of stocks. Notice that the sponsor issues ETF shares similar to what a mutual fund does. The difference is that the sponsor only deals with a set of APs who are financial institutions. Also, unlike a mutual fund, the ETF sponsor doesn’t receive cash in exchange for its shares. Instead, the sponsor receives a bundle of stocks that matched the portfolio designed by the sponsor. Okay, so what do APs do with their ETF shares? Also, so far, the investors haven’t been involved in any of the transactions. How do investors get in on some of the action and own some ETF shares for themselves? Well, the APs go to the stock exchange and sell their ETF shares on the open market. Investors can buy these shares and now have investments that are linked to all of the stocks that are in the ETF portfolio. What we’ve described so far is called the create process. In summary, the create process involves these steps. The AP buys stocks and gives them to the ETF sponsor. The ETF sponsor creates ETF shares and gives them to the AP. The AP then sells the ETF shares to investors. This is called the create process because it effectively creates more ETF shares that are available on the stock exchange.

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