Now, this may seem like a hassle for the authorized participants, but the truth is there are many ways for them to make educated guesses about where these securities should trade when their exchanges are closed. One popular method is to use the percent change of the US market (for example, via the S&P 500) and assume that other countries will have a similar move, while also incorporating the continuously traded foreign exchange market to account for currency movements.
But the takeaway for ETF investors is that there’s an unintended (but very important) benefit to all this, and that is that these US-domiciled international ETFs can actually continue to price in information about the underlying securities even when foreign markets are closed. It’s a phenomenon we in the ETF business refer to as “price discovery,” and it’s happening every day.
So let’s go back to our Lunar New Year example to see how this all applies. We already said that this price discovery process is happening every day due to time zone differences, but what happens when there’s an extended closure like this one? Because an ETF’s net asset value (NAV) is based on the last closing price of its underlying securities, you would expect the NAV for the ETFs in question to go stale over the course of the market closures. In other words, while the ETF’s market price will continue to price in new information, the NAV will remain the same. This can lead to a greater than usual difference between the NAV and the market price of the ETF.
How dramatic do we think this difference will be? Although we’d expect there to be some deviation between market price and NAV, price discovery may still keep these funds in-line with their fair value. But as time ticks forward, it becomes more difficult to determine the true value of the underlying holdings. It is worth noting that the bid/offer spreads on affected funds remained at normal levels during the previous Lunar New Year holiday, as did average daily volume. My team, the iShares Capital Markets Group, expects this year’s holiday to be no different.
The bottom line: Every day, in normal and abnormal markets, ETFs are an investment vehicle of choice for providing investors with price discovery. Time and time again, investors have looked to ETFs to get access to other markets, even when those markets may be closed. So Gung Hay Fat Choy. Enjoy the holiday – and remember that the closures of so many markets around the world shouldn’t impact your ability to trade an ETF here in the US.
Keegan Toci is an associate at BlackRock, which manages the iShares ETFs.