Who Constructs ETFs and How Are They Made
An overview of the ETF construction process
If you want to trade ETFs, or exchange-traded funds, it helps if you first understand the creation process for the funds. You can gain better insight into which ETFs make the most sense for your individual investment strategy. Understanding the securities underlying the ETFs can also aid you with your research and help you choose your next ETFs.
Who Creates ETFs?
ETF managers, also known as sponsors, design, develop and in most cases manage the exchange-traded fund. The sponsor files a plan with the U.S. Securities and Exchange Commission (SEC) to create the ETF. At times, the ETF provider will utilize the skills of other financial entities and partner with them to manage a new fund. This synergy may help produce a better exchange-traded product.
How Are The Funds Assembled?
The first step in the creation process is for an ETF sponsor or provider to decide which sector, commodity or market to track and then create a fund with the goal of emulating the underlying asset or representing index.
After finalizing the concept, the ETF provider files with the SEC to get the new fund approved. Factors that can affect the approval process include the use of derivatives such as futures or options, if the fund has a leveraged return, and the proposed management of the fund.
Upon completing the approval process, the ETF provider constructs the new fund using instruments such as stocks, options, futures, or other assets in such a way to best accomplish the goal. Many different types of investments can go into an ETF.
In some cases, the ETF provider may work with another participant who procures the assets in a fund and holds them in a trust. The ETF provider may also choose to handle this responsibility in-house.
Part of the design process concerns the type of ETF. The ETF might be actively managed, and it could be an inverse ETF. The return might be leveraged, and criteria such as dividends, interest, and volatility come into play as well.
Finally, if approved, the new ETF gets a symbol, a name, and a target launch date. Also, the ETF sponsor will make other decisions like where the new ETF will actually trade. From there it’s just a case of ringing the opening bell and the fund begins trading.
What to Look for in an ETF
It's important to understand the investments in your portfolio and how they work. You can learn much about an ETF by looking at its holdings.
However, some ETFs, particularly those that heavily utilize derivatives, can be a bit complex to examine. In those cases, researching the actual ETF performance, goals, and historical return, for example, can be more important than analyzing the construction itself. Before you make any trade, ETF or otherwise, do the research.
If you have any questions or concerns about any fund you may be considering, consult a financial professional such as your broker or advisor. No investment is without risk, ETF or otherwise. So be sure you understand any risk associated with any funds.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.