Are Exchange-Traded Funds (ETFs) less safe than regular mutual funds?

Question

I have read this question on the differences between both vehicles, but one the points was, perhaps, a bit under-emphasized: the relative risk.

I understand there are technical differences between both financial instruments, and I wonder if ETF's are further removed from the actual underlying holdings or assets giving value to the fund, as compared to regular mutual funds.

So, for instance, would VTI and Total Stock Market Index Admiral Shares be equally anchored to the underlying shares of the companies within the index? Are they both connected? Is VTI more of a "derivative"?

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Not to preempt potential answers, but I just came across this:

Question: What is the primary legislation regulating mutual funds and ETFs?

That’s right; the vast majority of ETFs are organized and regulated under the “1940 Act,” the same legislation that governs mutual funds. It imposes a host of investor protections, including those related to organizational structure and investment activities. This makes ETFs that are subject to the 1940 Act among the most stringently regulated investment products available in the United States. Since I’m on the topic of regulation, I’d add that from a shareholder’s perspective, taxation of 1940 Act ETFs and mutual funds is the same.

Answer 1

I wonder if ETF's are further removed from the actual underlying holdings or assets giving value to the fund, as compared to regular mutual funds.

Not exactly removed. But slightly different. Whenever a Fund want to launch an ETF, it would buy the underlying shares; create units. Lets say it purchased 10 of A, 20 of B and 25 of C. And created 100 units for price x. As part of listing, the ETF company will keep the purchased shares of A,B,C with a custodian. Only then it is allowed to sell the 100 units into the market. Once created, units are bought or sold like regular stock. In case the demand is huge, more units are created and the underlying shares kept with custodian.

So, for instance, would VTI and Total Stock Market Index Admiral Shares be equally anchored to the underlying shares of the companies within the index?

Yes they are.

Are they both connected?

Yes to an extent. The way Vanguard is managing this is given a Index [Investment Objective]; it is further splitting the common set of assets into different class. Read more at Share Class. The Portfolio & Management gives out the assets per share class. So Vanguard Total Stock Market Index is a common pool that has VTI ETF, Admiral and Investor Share and possibly Institutional share.

Is VTI more of a "derivative"?

No it is not a derivative. It is a Mutual Fund.

Answer 2

If anything, the price of an ETF is more tightly coupled to the underlying holdings or assets than a mutual fund, because of the independent creation/destruction mechanism.

With a mutual fund, the price is generally set once at the end of each day, and the mutual fund manager has to deal with investments and redemptions at that price. By the time they get to buying or selling the underlying assets, the market may have moved or they may even move the market with those transactions.

With an ETF, investment and redemption is handled by independent "authorized participants". They can create new units of the ETF by buying up the underlying assets and delivering them to the ETF manager, and vice versa they can cancel units by requesting the underlying assets from the ETF manager. ETFs trade intraday (i.e. at any time during trading hours) and any time the price diverges too far from the underlying assets, one of the authorized participants has an incentive to make a small profit by creating or destroying units of the ETF, also intraday.