Exchange traded funds are widely known for their transparent nature, providing anyone with a fund wrapper that closely mirrors its net asset value and a tool that reveals what investors will be exposed to.
Transparency in ETFs help facilitate efficient arbitrage opportunities to keep the price in line with the NAV and allows investors to easily look into their underlying holdings when construction a portfolio, writes Rusty Vanneman, chief investment officer at CLS Investments, for InvestmentNews.
ETFs trade like a stock on an exchange, with prices that fluctuate throughout the day. Consequently, if the ETF’s price is trading above its NAV, an authorized participant will sell the ETF for a basket of the underlying holdings at a profit, bringing down the ETF’s price to the NAV. On the other hand, if the price is below the NAV, the AP can buy the ETF for a basket of underlying securities at a profit.
Through arbitrage opportunities when an ETF is trading at a premium or discount to its NAV, market makers help diminish deviations from the NAV or so-called ETF tracking errors. Consequently, knowing that the an AP will help keep tracking errors to a minimum for the majority of ETFs, investors are confident that the ETF wrapper will reliably reflect the value of its underlying market.
Additionally, the ETFs’ transparent nature also allows investors to closely scrutinize individual holdings and sector tilts.