There have been a lot of scary articles in the mainstream media about exchange-traded funds lately. As market volatility increased in June, publications including the Financial Times, the Wall Street Journal and Bloomberg all penned articles warning investors about the perils of investing in ETFs.
The articles were extraordinarily mixed in their quality and accuracy, jumbling together true concerns with absolute misconceptions. Here is a primer that separates truth from fiction, arranged from false fears to real worries.
Fear No. 1: International Equity ETFs Not Trading At NAV
Actual Concern: Almost None
Outlets like Bloomberg and the Financial Times ran scare-mongering articles recently warning investors about international equity ETFs trading away from their net asset values (NAVs).
The Financial Times, for instance, noted after one volatile day that “the share price of the iShares MSCI Emerging Markets ETF fell to a 2.6 percent discount to the underlying asset value.”
This is just silliness. The problem here isn’t with the ETF, but rather, with the rules around how ETFs report their “underlying asset value” or (to use the actual term) “net asset value” (NAV).
All ETFs must report their NAV at the end of each trading day. The calculation involves looking at the last traded price for the securities the ETF holds, adjusting for any currency movements and calculating the NAV. All else being equal, one would expect an ETF’s share price to trade close to the NAV.
But what happens when you have an ETF invested in China? China is on the other side of the world, so its markets are closed during the trading day in New York.
Let’s imagine that something bad happens during the course of the trading day in New York: say, Bernanke hints at a rate rise. All securities -- including our China ETF -- will trade lower, because this is bad for investors.
But the NAV? It won’t move, because the Chinese markets aren’t open. So at the end of the day, the Chinese ETF will trade at a “discount” to its official (but by now very stale) NAV.