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I’m wondering if significant asset inflows to an ETF affect its underlying stocks.

For instance, ARK disruptive innovation ETF have seen significant inflows in the past 3 months, around $7 billion.

Also, the ETF holds many micro and small cap stocks.

Hence, does the significant inflows affect the market prices of the underlying equity securities directly or indirectly?

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Most likely. If the ETF has more buyers than sellers, the sponsor or authorized participants will have to create units of the ETF. In order to create units of the ETF, they will have to go to the market to purchase the underlying shares. More buying of the shares tends to make the share price increase.

Edit: I say most likely because the ETF and the underlying shares have its own liquidity characteristics. The theoretical ETF value is the weighted average sum of the component shares. If despite the demand for the ETF, there is selling of an individual stock, a particular stock price may go down. Consequently, the ETF may trade at a discount or premium to it's underlying share values. There are market participants that play this ETF arbitrage. They will buy (sell) the ETF if it is trading at a discount (premium) and sell (buy) the underlying components in an attempt to capture the discount or premium. Some arbitrageurs will make this trade utilizing statistical arbitrage and not buy or sell the complete basket of underlying stocks. The statistical arbitrageurs (and full replicators) will use the creation/redemption process to create the ETF or break up the ETF for the underlying components should they want to sell or source the underlying shares. They may then buy or sell the remaining shares (the tail) in the open market. The arbitrageurs help keep the ETF and the underlying shares to trade in line with each other.

In fact, the ETF market is now used to facilitate basket underlying trading through the redemption/creation process.

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  • $\begingroup$ I’m asking the question because I wonder if significant cash inflows have caused the ETF (Ticker: ARKK) to significantly outperform the S&P 500 ~ YTD excess return is upward of 70%. Or at least excess returns can be partially explained by the inflows. $\endgroup$
    – user28909
    Dec 25 '20 at 7:11
  • $\begingroup$ I think it also depends if the fund physically samples or uses a synthetic replication. In the latter case an ETF does not need to buy all underlying stocks. $\endgroup$
    – hannes101
    Dec 26 '20 at 22:51

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