Investing term

What is Creation/redemption?

The mechanism that keeps ETF prices close to NAV. Authorized participants swap baskets of underlying stocks for ETF shares (or vice versa).

Creation/redemption is the behind-the-scenes mechanism that keeps an ETF's price glued to the value of its holdings. Large institutions (authorized participants) can swap a basket of the underlying stocks for new ETF shares, or vice versa. This arbitrage means that if the ETF drifts above or below its true value, traders profit by closing the gap — keeping price and value in line.

For example

If an ETF trades slightly above its holdings' value, an authorized participant creates new shares and sells them, nudging the price back down to fair value.

Creation/redemption is taught hands-on in Stage 6 — Index Funds, ETFs & Mutual Funds.

See the lesson →

Related terms

Active fundA fund whose manager picks stocks in the hope of beating a benchmark.BenchmarkThe reference index a fund compares itself to — e.g. the S&P 500, MSCI World, or Bloomberg Aggregate.DistributionThe income a fund pays out to its shareholders — dividends from stocks held, plus realized capital gains.ETFExchange-Traded Fund — a basket of many stocks (or bonds) bundled into a single share that trades on an exchange like a regular stock.
← Back to the full glossary