ETF (Exchange-Traded Fund), is an investment product representing a basket of securities that track an index such as the Standard & Poor’s 500 Index. ETFs, which are available to individual investors only through brokers and advisers, they trade stocks on an exchange.
In theory all that a fund manager needs to do is establish clear procedures and describe precisely the composition of the ETF (which changes infrequently) to the other firms involved in ETF creation and redemption.
In practice, however, only the very biggest institutional money management firms with experience in indexing tend to play this role, such as Barclays Global Investors and The Vanguard Group. They direct pension funds with enormous baskets of stocks in markets all over the world to loan stocks necessary for the creation process. They also create demand by lining up customers, either institutional or retail, to buy a newly introduced ETF.
The process does allow for transparency and liquidity at modest cost. Everyone can see what goes into an ETF, investor fees are clearly laid out, investors can be confident that they can exit at any time, and even the authorized participant’s fees are guaranteed to be modest. If one allows ETF prices to deviate from the underlying net asset value of the component stocks, another can step in and take profit on the difference, so their competition tends to keep ETF prices very close to it underlying Net Asset Value (value of component stocks).