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Consider an ETF with tick symbol TIP and a customer clicking 'Sell' to sell one share via Fidelity brokerage. How can the customer know if that single stock will be bought by another person on the stock exchange or by the 'fund' itself.

This is motivated by the fact that, unlike a stock like MSFT, a fund can see an outflow or influx of money. E.g., piece of news like this one:

TIPS ETFs See Outflows as Investors Scale Back Inflation Bets

Can you explain how outflows are exactly achieved? What happens if 50% of investors decide to sell and no one wants to buy? And there is outflow of $5B out of yesterday total ETF sum of $10B.

  • "no one wants to buy" The stock market is seldom as simple as that; most of the time it's better understood as a stack of people who would want to buy if the stock were cheaper, and some different people who would want to sell if the stock were more expensive. The lower the price is, the more people will be interested in buying it. This is why trading a stock affects its price - you run out of people at the top of one of the stacks. For an ETF consisting of stocks actually worth something, there's a financial incentive for a computer program to buy it if the ETF price itself drops too low. – fennec May 10 '13 at 20:49
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ETF Creation and Redemption Process notes the process:

While ETF trading occurs on an exchange like stocks, the process by which their shares are created is significantly different. Unless a company decides to issue more shares, the supply of shares of an individual stock trading in the marketplace is finite. When demand increases for shares of an ETF, however, Authorized Participants (APs) have the ability to create additional shares on demand.

Through an "in kind" transfer mechanism, APs create ETF units in the primary market by delivering a basket of securities to the fund equal to the current holdings of the ETF. In return, they receive a large block of ETF shares (typically 50,000), which are then available for trading in the secondary market. This ETF creation and redemption process helps keep ETF supply and demand in continual balance and provides a "hidden" layer of liquidity not evident by looking at trading volumes alone.

This process also works in reverse. If an investor wants to sell a large block of shares of an ETF, even if there seems to be limited liquidity in the secondary market, APs can readily redeem a block of ETF shares by gathering enough shares of the ETF to form a creation unit and then exchanging the creation unit for the underlying securities.

Thus, the in-kind swap to the underlying securities is only done by APs so the outflow would be these individuals taking a large block of the ETF and swapping it for the underlying securities. The APs would be taking advantage of the difference between what the ETF's trading value and the value of the underlying securities.

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The way it is handled with ETF's is that someone has to gather a block of units and redeem them with the fund. So, with the mutual fund you redeem your unit directly with the fund, always, you never sell to another player. With the ETF - its the opposite, you sell to another player. Once a player has a large chunk of units - he can go to the fund and redeem them. These are very specific players (investment banks), not individual investors.

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