ETF mechanics and ecosystem

Welcome to our ETF education video series. In this first video, we’re discussing the basics of the ETF ecosystem. Specifically, we’ll be identifying the primary and secondary markets that ETFs trade in.

So, let’s start with the primary market: where ETF shares are created and redeemed. An important feature of ETFs is that the supply of shares of an ETF can be increased or decreased to meet demand for those shares in the marketplace. This is a crucial dynamic for keeping share prices aligned with underlying net asset value.

Simply put, when more shares are needed, they are created, and when fewer shares are necessary, shares can be redeemed. This creation and redemption of shares is known as the primary market.

Now only certain entities – known as authorized participants, or “APs” – can create or redeem shares directly with the fund. When an AP needs to create more shares, they deliver a basket of securities and/or cash to the fund in exchange for the equivalent value of ETF shares. When an AP needs to redeem their ETF shares, the exchange works in reverse and they return the ETF shares for a basket of cash or securities.

These primary market transactions take place in large blocks of shares called creation units.

Looking now at the secondary market – ETF shares that have been created are then traded by investors, much the same as stocks.

Secondary market trading largely happens on an exchange, like the New York Stock Exchange or Nasdaq – venues where end investors can buy or sell positions in the ETF.

Specialized trading firms called market makers play an important role in the secondary market ecosystem by providing liquidity to those investors trading on the exchange. As secondary market trading takes place, market makers can work with APs to source or redeem shares as necessary.

Now, instead of trading at net asset value, ETF shares in the secondary market are traded at market prices throughout the day.  The ecosystem is able to keep markets efficient, and those secondary market prices closely aligned with the underlying value due to that ability to dial the supply of ETF shares in the market up or down through the creation/redemption mechanism.

Tune into the next video in this series to better understand ETF liquidity and clear up some common misconceptions. And if you are interested in learning more about the lineup of ETFs at Thrivent Asset Management, connect with a dedicated Thrivent consultant serving regional and national accounts at ThriventETFs.com/contactus.