ETF Trends
ETF Trends

One of the top trending stories Friday was a Financial Times article about how Thursday’s market chaos caused a $33.5 billion emerging market ETF to trade at a steep discount to its net asset value.

The iShares MSCI Emerging Market ETF (NYSEArca: EEM) shares traded at a 6.5% discount to the underlying asset value, the FT reported.

First off, the reporters appear to have calculated that 6.5% discount by comparing the Wednesday closing net asset value (NAV) to where EEM’s share price closed on Thursday.

The discount to NAV was actually 2.6% at Thursday’s close versus the official EEM closing price of $36.88 a share.

However, there is nothing sinister about EEM trading at a discount of nearly 3% to NAV.

Why? Because that NAV was several hours old, while EEM continued to trade in real time.

“Approximately 75% of the EEM basket is closed during the U.S. session,” said Christine Hudacko, a spokeswoman for BlackRock, which manages the iShares ETFs, in an email. “Thus, 75% of the basket was not incorporating the negative market move during the US session [on Thursday]. The market’s expectation of where those closed securities would trade the next day is the price discovery dynamic we see every day in our products.”

The key thing to remember is that U.S.-listed ETFs tracking foreign stocks are trading while the underlying markets have already closed for the day. The ETF share prices are incorporating new information that’s hitting the tape after the overseas market has closed.

Yes, any ETF indexed to international markets can trade at a “discount” or even “premium” to NAV. But really, who cares? The NAV is based on prices that are stale.

“The main issue with funds that track emerging market securities is that most of the underlying holdings do not trade during our market day,” said Morningstar senior fund analyst Patricia Oey. “So the ETF is essentially a price discovery vehicle for that asset class. Widening spreads for emerging market ETFs reflect the market’s anticipation that emerging market stocks will fall further when their markets open. And at the end of our market day, these ETFs tend to close at a discount to their NAV on days like yesterday [Thursday].”

She notes that EEM and Vanguard FTSE Emerging Markets ETF (NYSEArca: VWO) fell 4.5% and 4.3%, respectively, during Thursday’s global sell-off, which is fairly similar performance. But the discounts were different at 2.6% for EEM and 1.6% for VWO.

“While they do not track the same index, EEM and VWO are very similar funds,” Oey said in an email. “The reason for [the different discounts]is because VWO (Vanguard) uses a fair value approach to calculate its NAV, whereas EEM (iShares) does not.”

In other words, the Vanguard ETF traded at a smaller discount because the fund updates its NAV in an effort to reflect fair value after the overseas markets close. It’s a best guess.

The FT story seems to imply that the EEM discount reveals a flaw in the ETF in a unsettled market. In fact, the ETF was trading as it should have.

Next page: Citi stokes ETF worries

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