Six elements of the difference between two kinds of investment company.
The older mutual fund system works in an entirely different way. The buys and sells of fund shares take place once a day and are handled by the operator of the fund. If a no-load fund’s portfolio is worth $50.05 per fund share at the end of the trading day, all the buys and sells take place at that price.Not all market makers in the shares of an ETF are the same. Some, called “authorized participants,” do more than just quote bid and ask prices.
If more investors want out than in, the process works in reverse. The authorized participant buys unwanted ETF shares for cash. It hands in a big block of ETF shares, gets in return stock in Apple, Amazon and the rest, and then sells those positions. Proceeds from the 500 sell transactions repay the middleman for cash laid out in acquiring the unwanted shares.
One is that an ETF rarely has to sell positions for cash; instead, it’s mostly just swapping stock in Amazon and Apple and so on for fund shares. The other is that for this swap the ETF can select its lowest-cost lots of Amazon and Apple. With this maneuver, the fund is left with high-cost shares on its books. If it does do any selling for cash, for example to realign the portfolio, it will probably end up with few gains, or even a net capital loss at the end of the year.
Some ETFs are actively managed. These account for only a sliver of the industry’s assets, but they are becoming more common.
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