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Advisors know as much, but many investors aren’t aware that ETFs have two prices: the price they see on their screens via their brokerage accounts, also known as the market price, and net asset value (NAV).
In the essence of demystifying ETF NAV, it’s important to clients because it’s “the value of each share’s portion of the fund’s underlying assets and cash at the end of the trading day,” according to Investopedia. “The NAV is determined by adding up the value of all assets in the fund including assets and cash then subtracting any liabilities and finally dividing that value by the number of outstanding shares in the ETF.”
Since I’ll be citing WisdomTree research in this piece, the image below illustrates the differences, usually modest between, the market price and NAV of the $16.62 billion WisdomTree U.S. Quality Dividend Growth Fund (DGRW).
Understanding NAV, Market Price Differences
Ideally, the market price and NAV differences would be negligible across the ETF landscape, but that’s not always the case. Some of the discrepancies are attributable to liquidity of underlying assets – occasionally a point of particularly in some corners of the bond market.
“Some ETFs hold assets that are less liquid than the ETF shares themselves. High yield bond ETFs are one potential example, in that the underlying bonds may trade infrequently, with wide bid-ask spreads, but the ETF shares may trade continuously,” notes Christopher Gannatti of WisdomTree. “During periods of market stress, the ETF's market price can fall faster than the NAV, not because the ETF is broken, but because the market price is incorporating forward-looking information about where those bonds might clear if they actually traded.”
With international ETFs trading in the U.S., there are often market price/NAV gaps because many of those markets are closed for the entirety of the U.S. trading session. So say an investor is engaged with a Japan or South Korea ETF. The underlying stocks are closed for business when the U.S. session starts, but if some seismic event occurred in Asia overnight, the US-listed ETF will price that in at the open.
The good news is that whether it’s domestic or foreign stocks or another asset classes, most significant dislocations of market price and NAV can be nimbly dealt with by the authorized participants that are vital to the ETF creation/redemption process.
“This means that if an ETF's market price rises meaningfully above its NAV (a premium), authorized participants can profit by delivering the cheaper underlying basket and selling the pricier ETF shares, and this is a trade that pushes the market price back down,” adds Gannatti. “The reverse happens when ETFs trade at a discount. This mechanism is elegant, self-correcting, and one of the genuinely clever pieces of financial engineering in the ETF structure.”
Don’t Fret Too Much About NAV, Price Differences
It pays to remember that the reason advisors and clients see two prices with ETFs is because the Securities and Exchange Commission (SEC) requires issuers to publish and update both figures.
At the end of the day, NAV is presenting investors with a figure on the value of the ETF’s assets while market price reflects trading action in said fund. The differences aren’t something for investors to lose sleep over, but a little education goes a long way.
“For most domestic equity ETFs, in most periods, the two numbers will be close,” concludes Gannatti. “But in markets under stress, in funds holding hard-to-price assets, or in international funds spanning multiple time zones, the gap between them can become more meaningful, and this is a window into market sentiment, liquidity conditions, and the mechanics of how price discovery actually works in the real world.”
Related: Vanguard Just Passed iShares: How the ETF Giant Won by Keeping It Simple