Exchange traded funds (ETFs) are an investment vehicle that basically reflects an investment on a group of underlying securities. Consequently, many have looked at the net asset value, or NAV, as a good indicator of what an ETF is worth.
However, the NAV is not as binding as one might think. Dave Nadig, Director of Exchange Traded Funds at FactSet, argued that there are tow big myths surrounding the NAV: The NAV is the portfolio holdings divided by the number of shares in a fund. NAV is what all the securities are worth.
NAV may not be a snapshot of precisely what is going on in a fund, but rather a best guess of what a portfolio is worth. For ETFs, which trade throughout the day like common stocks, investors will require a different set of indicative values to help reflect the shifting ETF prices throughout the day. In an attempt to guide trading on ETFs, the indicative NAV or iNAV provides a more real-time view of value throughout the trading day. The iNAV is typically calculated every 15 seconds during normal hours.
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However, the NAV becomes a more vague value when the markets close. Since many funds tracks international bonds and equities, there are no up-to-date underlying values to precisely gauge the worth of a fund that follows overseas markets.
“The most important thing about ETFs is that NAV isn’t a transactional price,” Nadig said. “With the exception of some fixed income funds that use cash creations, NAV isn’t actually used for anything. It’s a reference price. Most ETF transactions happen in the open market, at a market derived price, and the creation process doesn’t intersect with NAV at all. And as a reference price, the ETF issuer has to decide what they’re trying to communicate with that reference price.”
[related_stories]For instance, an ETF that tracks developing countries will follow markets across a number of time zones, many of which are not open during normal U.S. hours. Consequently, the “fair” price is whatever the market determines it to be.
“The only thing you know for certain is what the prices were when all those markets were last open,” Nadig said. “But you’re not buying at NAV; you’re buying at a market price.”
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Consequently, an ETF’s price will show greater discrepancies in their premiums or discounts to NAV. Behind the scenes, Authorized Participants who create and redeem ETF shares will have to wait until those markets reopen to create new shares of an international ETF to bring the price back in line to the NAV.
“For investors, this means one thing primarily: ignore premiums and discounts (the difference between closing prices and NAVs) as displayed pretty much anywhere for international ETFs,” Nadig added.