Since an index fund is ran by a separate company to follow a market index (like the S&P 500), and is not actually the index, how does it match the index movement?
I know the fund managers buy shares of stock represented by the index. But it’s a separate stock that can be traded by investors, so it can take on a trend of it’s own right?
In: Economics
There are two types of index funds–mutual funds and ETFs.
Mutual funds are not “a separate stock”. They don’t trade throughout the day. They only trade once a day while the markets are closed, and trade at the NAV (net asset value) computed based on the closing prices of all the stocks it contains. So it can’t have a trend of its own.
ETFs do trade like stocks. They can develop a trend of their own, but there are “authorized participants” who can break a large block of ETF shares into the proper number of shares of all the underlying stocks, or the other way around. If the ETF trended too far away from the aggregate of the shares it holds, then the authorized participants can make money by doing this trade in whichever direction makes sense, and by doing so they will correct the trend.
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