Creation and redemption

Creation and redemption is the process that allows the supply of ETF shares to expand or shrink to match investor demand, keeping the fund's market price closely aligned with the value of its underlying holdings. It is the key structural feature that separates ETFs from closed-end funds, which have a fixed share count, and from ordinary stocks, which do not have this mechanism at all.

New ETF shares are created when an authorized participant delivers a basket of the fund's underlying securities, or in some cases cash, to the ETF issuer in exchange for a large block of new shares, known as a creation unit, which the authorized participant can then sell to investors on the exchange. Shares are redeemed in reverse, an authorized participant buys a large block of ETF shares on the exchange, delivers them back to the issuer, and receives the underlying securities or cash in return. This flow only happens in large blocks, typically tens of thousands of shares at a time, and only through authorized participants, not individual investors.

Because authorized participants profit from correcting any gap between an ETF's market price and its underlying value, creation and redemption activity tends to happen automatically whenever that gap becomes large enough to be worth acting on. This is what keeps most ETFs trading close to their net asset value throughout the day, and it is also what allows an ETF's total assets to grow or shrink smoothly as money flows in or out, unlike a closed-end fund where share count cannot adjust the same way.