How exactly do ETFs work
To give due credit, most of this was originally mentioned by UCLAgrdstnt (in response to a pick of SKF by Intelledgement). I read all of Intelledgement's response, but I'm hoping to get a more definitive answer to a couple of points.
1) If an ETF is supposed to track and index, or the inverse of an index, or double an index's daily performance or double the inverse of an index's daily performance how exactly is that supposed to work? I don't mean: how do the manager's get that to happen. Rather, since the ETF trades like a stock with supply and demand dictating the bid/ask prices, doesn't this mean that the ETF tracks investor's sentiment of how they think the index is going to perform rather than how it is actually performing?
So which is it? Does the ETFs trade like a stock and supply/demand dictate the pricing or is it based on how the index performs. I think it has to be some kind of combination (like the market maker keeps the bid/ask somewhat around the NAV of the ETF but the market will determine the pricing within a certain acceptable range). But that is just my opinion. Does anyone know what the 'truth' is?
2) How are expense ratios deducted from ETFs. Obviously the management is getting paid (as they should, more so with some of the more exotic ETFs out there). Obviously they are not saying that we're collecting our fee on such and such a date each year or month. So how do they skim their portion over the course of time? I don't think they can be getting a cut of each transaction, but anything is possible. The fee has to be reflected in the price of the ETF over the course of time somehow. I'm thinking of ETFs that track indices or commodity prices mainly, but I would think this problem would apply to any ETF out there. Anyone have any insights on this?
Responses will be greatly appreciated.