As we all know, ETFs are traded on exchanges, which means that if I buy one, someone else is selling it. Therefore, the money I pay for the ETF goes to the seller, not the AMC. So, how do the ETF AMCs generate AUM?
They just create new units and sell on the market, especially when there is a very high demand and NAV on the exchange is getting further away (premium) from the real NAV.
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At the portfolio level they do charge commission. This is their income.
Yeah.
How the AMCs charge expenses for ETFs, really seems to be a puzzle.
I know ETFs are just MFs which can be traded on the exchange.
But, with Mutual funds, it is very clear how they charge for the expenses, because we deal directly with the mutual fund AMC when we buy or sell units, and the money directly goes to the AMC, and we always buy/sell at the EOD NAV which is calculated after accounting for the expenses.
But when it comes to ETFs, we are probably dealing with 3 parties, the retail investors, market makers and the AMC
And i don’t get how they charge for the expenses, when it is very much possible that both the buyer and the seller are retail investors.
The AMC can charge me, only if I directly pay them right? if the transaction is between 2 retail investors, how does the AMC come into this picture, and how does it charge, if it doesn’t receive the money directly?
I did come across this thread relating to ETF expense ratio, but didn’t get any clarity as to how the expenses actually get charged in case of an ETF.
Wonder how ETFs charge for expenses, when the transaction is taking placing between retail investors (although not always), especially when the transaction is taking place at market price and not necessarily at the NAV of the underlying assets.
…anchored around the NAV
which is based on the underlying-holdings + dividends - expense-ratio.
If the market-price in the secondary markets (eg. NSE, BSE)
starts to deviate from the NAV of the ETF,
then the fund-house can step-in to start buying or selling ETF units
as necessary to nudge the market-price towards NAV
(and while at it earn profits on it , as they get to pocket the difference).
As the fund-house has the power to create and extinguish ETF units,
any difference in the market-price of ETF from its NAV
(which, in turn, is based on the value of the underlying components of the ETF),
any such difference is an arbitrage opportunity for the fund house.
Is the absence of an active fund house that does this diligently,
ETFs can be illiquid and sell for a premium/discount on secondary markets (tracking error).
Upon encountering such a scenario,
3rd-party “market-makers” will likely engage in arbitrage of such an ETF, and pocket the difference,
which results in helping anchor the ETF market-price closer to its NAV.
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I guess i understand it now, although not entirely.
First when the AMC comes up with an NFO for a new ETF, all subscribers will be paying the AMC directly and this would become the base AUM.
The AMC will use this cash to invest in shares of the companies forming part of the ETF.
And based on how the ETF performs along with the future creation and redemption of units, the AUM will keep changing (↑/↓).
If the transaction is taking place between two retailers, the AUM will remain unaffected, because when the seller exits, the buyer takes his place.
i.e., The AMCs AUM doesn’t get affected because when 2 retailers transact among themselves, the units just change hands, the AMC doesn’t sell any shares to pay the seller or receive any cash from the buyer.
The AMC can therefore charge expenses daily on the AUM based on the EOD NAV and maybe take this out of the uninvested cash lying with them or some other way.
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Hey, both Mutual Funds and ETFs are mutual fund units and are treated similarly. The additional layer in the ETF is that it is traded on the exchange. So lets take the eg of a Nifty100 Index Fund and a Nifty100 ETF having being launched at the same time with everything being the same. Both would have similar portfolios at the back end and both have NAVs declared at EOD on which TER, etc would be applicable. The additional layer in an ETF is that it is traded on the exchange and therefore other dynamics also play a part on the counter such as demand-supply dynamics, market makers, etc. The structure of an ETF is such as it allows investors to execute real-time while in a Mutual Fund its EOD. Hope this helps!
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Thanks for the reply.
My confusion around how AMCs charge for expenses in relation to ETFs, mainly arose because of how AMCs get the money for ETFs after the initial NFO subscription.
I understand that, subsequently, the money to create new units, comes from the market makers or HNIs.
Since the AMC can only create and redeem units in what’s called the creation size (creation unit), this requires a lump sum investment, which means only the market makers or HNIs can directly deal with the AMC to create or redeem such units.
In mutual funds, retail investors can invest small amounts into the fund and the fund pools this money and then invests them in the underlying assets.
For ETFs though, investors don’t directly deal with the AMC after the NFO, it seems like market makers play the intermediary role, by buying and selling units, infusing liquidity.
Thats right. ETF is a unique structure. Compare it to say a close-ended scheme which is also listed but is illiquid and pricing is opaque. The creation unit concept is what makes the ETF provide real-time pricing.
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