Why are ETFs different from closed-end funds?
ETFs are different from “closed-end” funds in many ways; one of the more important differences is that “closed-end” funds issue a finite number of shares. ETFs, however, are structured as open-end investment management companies or unit investment trusts – continuously issuing new shares and redeeming existing shares. This provides needed liquidity for the buy and sell sides of the market. However, these transactions with the fund itself may only be done in very large size transactions referred to as Creation Units, and are done by depositing with or receiving from the ETF the actual securities that are part of the index, not just cash. Because of their large size, these transactions are done by institutional investors, and they provide for an arbitrage between the price of the ETF on the Exchange and the price at which an institution can create or redeem from the fund. It is this arbitrage situation that permits the ETF to avoid the kinds of discounts or premiums from net-asset value
