ETF investing 101
ETF investing 101
Market price and Net asset value
ETF is a basket of stocks. The market price is the most recent price at which an ETF traded.
The net asset value NAV is the value of all securities and other assets held in the ETF, less liabilities, divided by the number of outstanding ETF shares. It’s calculated at the end of each trading day.
Generally, an ETF’s market price trades fairly close to its NAV. However, there are circumstances when an ETF may trade at a premium (the market price is above the NAV) or at a discount (the market price is below the NAV).
Premium and discount
A premium or discount to the NAV occurs when the market price of an ETF on the exchange rises above or falls below its NAV.
If the market price is higher than the NAV, the ETF is said to be trading at a “premium”. This could be because strong demand for an ETF will push its market price above its NAV.
Conversely, strong selling pressure will tend to push the market price towards a discount. If the market price is lower than NAV, it is trading at a “discount”.
Therefore, the NAV will give you a good sense of an ETF’s fair value throughout the day.
Note that premiums and discounts are often unrelated to movements in an ETF’s market price. When the market price of this Index ETF was going down, yet the ETF still traded at a premium.
This happens during the times of market stress, there could be a higher proportion of stocks that become suspended from trading.
If a significant amount of the underlying stocks are suspended, it would make the NAV a less reliable indicator of the ETF’s underlying value.
Additionally, during market stress, it can sometimes be difficult to value illiquid securities such as bank loans, high yield bonds and ETFs with a high proportion of synthetic securities. Under such conditions, an ETF’s traded price may provide the best reflection of its true value.
Generally, an ETF’s market price won’t stray far from its NAV. Large discounts and premiums do not last long because they are quickly arbitraged away through the ETF creation or redemption process.
Otherwise, there could be situation of price dislocation.
Here is a example of news I read in financial times:
“Vanguard’s $55bn fixed income ETF hit by price dislocation
Gap between closing price and vehicle’s net asset value surged to a 6.2% discount last week”
“Extremely volatile conditions across the US fixed income market because of the coronavirus pandemic have led to a highly unusual pricing dislocation in Vanguard’s $55bn total bond market exchange traded fund, one of the world’s largest ETFs.”
The ETF it is talking about is BND. BND is structured as a share class in Vanguard’s $269bn Total Bond Market mutual fund, the largest of its type in the world. On 12 March 2020, it has a price dislocation of 6.2% between its closing market value and its net asset value.
“Market prices for ETFs can move more rapidly than the net asset value. That is part of the price discovery process.” Vanguard representative responded.
So we have to be aware of the market price volatility and at least understand the basics of how ETF works.
Link of the financial times article on BND: https://www.ft.com/content/3d452b5c-a767-48ad-9b8d-ba3af7d54419
Where can you find market price and NAV?
You can find each of these prices online. For example, you’ll find the iNAV, closing NAV, market price and closing market price of Vanguard S&P 500 Index ETF (3140) in the left-hand column of its overview page.
Note: this is not investment advice. I’m not a financial planning professional. Just sharing what is working for me as part of my investing strategy or what I have learnt on my investment journey. Please be reminded to do your own research and consider your own circumstances before making any financial decisions. You could also check with your financial professional to understand what would be best for your situation.