How ETF NAVs are calculated

How ETF NAVs are calculated

Exchange-traded funds (ETFs) are designed to closely follow the net asset value (NAV) of their underlying portfolios, but premiums and discounts to NAV can arise. It’s important for investors to understand why ETF premium and discounts can happen, as well some ETF best practices to make sure they’re getting the best price possible on trades.

Most ETFs are required to disclose an estimated NAV every 15 seconds throughout the trading day. The NAV is determined by adding up the combined value of all the ETF’s individual holdings plus its cash and is usually expressed on a per-share basis. The price of an ETF share generally stays very close to NAV but if the share price is below the NAV, then the ETF is said to be trading at a discount. Conversely, if the ETF share price is more expensive than NAV, the ETF is said to be trading at a premium.

There are several reasons why an ETF may trade at a premium or discount. Also, a premium or discount doesn’t automatically mean the ETF isn’t functioning properly. For example, U.S.-listed ETFs that invest in international stocks may trade at premiums or discounts to NAV when the underlying markets they invest in are closed due to time-zone differences. In other words, the NAV may be “stale” because the markets in Europe or Asia may be closed, for example. In fact, the ETF share price may reflect price discovery because investors are expressing a view on a particular market while it’s currently closed for trading. In other words, the ETF share price may be more accurate than an NAV that may be several hours old.

Premiums and discounts to NAV in bond ETFs may also occur for somewhat similar reasons because of the way that fixed income markets operate. Specifically, many bonds are traded over-the-counter and may trade infrequently – sometimes not for days or weeks. That may lead to stale or outdated NAVs for the underlying portfolios of some bond ETFs. So, premiums and discounts may happen in bond ETFs but that may simply reflect investors using bond ETFs for price discovery rather than trading the underlying individual bonds. Again, the ETF share price is more “current” than the NAV.

To summarize, premiums and discounts to NAV may happen in ETFs, but it’s important for investors to realize why they’re happening and that they may not reflect an operational shortcoming by the ETF. Also, premiums and discounts may be more likely to arise in fast-moving, volatile markets. Therefore, investors should keep a few best practices in mind when buying and selling ETFs in volatile markets:

1. If possible, avoid trading near the market open or close (approximately 30 minutes).
2. Contact ETF providers’ capital markets teams that can help facilitate large trades (available for financial professionals or talk to your financial professional).
3. Consider using limit orders instead of market orders,¹ particularly in volatile markets to help with best execution.