How ETF creation and redemption works

The share-supply mechanism that keeps ETF prices near NAV and drives fund flows.

ETF shares are not fixed in number. Large institutions called authorized participants (APs) can create new ETF shares by delivering a basket of the underlying securities to the fund, or redeem ETF shares by handing them back in exchange for the basket. Creation happens in large blocks called creation units (often 25,000–100,000 shares).

This mechanism is why ETF prices track NAV: if an ETF trades rich, APs create shares (selling the expensive ETF, buying the cheap basket) until the gap closes; if it trades cheap, they redeem. It is also what 'fund flows' measure — net creations are inflows, net redemptions are outflows.

Because redemptions are usually paid 'in kind' (with securities, not cash), the fund can hand out its lowest-cost-basis shares, which is the engine behind ETFs' tax efficiency.