ETF underlying value
I used ETFs as part of my investment allocation. Unlike mutual funds which are priced at NAV (net asset value) at the end of the business day, ETFs could trade at a premium (higher than NAV) or at a discount (below the NAV) throughout the trading session. Obviously, everyone hopes to buy at a discount and sell at a premium.
While closed-end funds could trade at discounts and premiums as large as 15%, the discounts and premiums of ETFs are normally quite small, typically less than 1%. This is due to the built-in arbitrage mechanism that allows big financial institutions to profit from any discount or premium in the traded value. This helps to keep the spread narrow.
For example, if an ETF is trading at a premium, an institution can exchange the equivalent basket of stocks with the fund manager for ETF shares to sell in the open market, profiting from the price premium. This continues until the premium disappears. The converse is true if the ETF is traded at a discount: an institution can buy ETF shares from the market at a discount and then exchange the ETF shares for the equivalent basket of stocks. The fees charged by the fund manager, the minimum block size and the liquidity of the underlying stocks are factors that will affect how efficient the arbitrage mechanism will work out to keep the trading premiums / discounts small.
In general, I try to avoid buying ETFs at a premium. ETFconnect is a wonderful resource for ETF information and it publishes the history of trading premiums and discounts of many ETFs and closed-end funds at the end of the trading day. However, this is not very useful when you are trying to find out if an ETF is trading at a premium or discount in the middle of a trading session.
Fortunately, the stock exchanges publish the real-time NAV of ETFs. You can easily get the real-time NAV of ETFs through Yahoo’s stock quote. For example, the underlying trading values of three common ETFs, VTI, EFA and VWO are ^TSJ, ^IEE and ^HVO, respectively. The trading values and underlying trading values of the above are shown HERE. A sample display is shown below:
You can usually find the ticker for the underlying trading value from the respective fund manager’s website.
Stumble it!
September 16th, 2006 at 6:12 am
I generally agree with your thoughts, but I’m concerned about the accuracy of the statement that “the stock exchanges publish the real-time NAV of ETFs”. The prospectus for VWO says,
“The Fund employs a “passive management”—or indexing—investment approach by investing substantially all (normally about 95%) of its assets in the common stocks included in the Select Emerging Markets Index.”
So if we check the value of 100% of ^HVO, there is a substantial margin of error (much less than 5%, yes) in our attempt to learn the NAV of VWO. I also worry about various forms of “stale inventory” – that is, suppose we just happen to buy VWO a day after the index is reconstituted?
I agree that these errors are relatively small, especially for a long-term investor. But the information we’re hoping to capture about premiums/discounts is of the same order of magnitude.
September 16th, 2006 at 9:47 am
TM, thanks for your thoughts. I haven’t thought from your angle of the words “real-time” when I made the post. Let me clarify that my intend of using the words “real-time” was to distinguish it from the “delay-quote” associated with the stock quotes from Yahoo finance.
This means that at any time instant during a trading day, the Yahoo finance quote for VWO is actually 15 to 20 minutes delayed compared to the quote from ^HVO.