ETFs that do not reflect NAV are a feature, not a bug

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ETFs began in 1989 with index participation stocks, a proxy for the S&P 500 traded on the US stock exchange.

Are emerging market ETFs trading weird or offering exactly what they’re supposed to?

China-dedicated ETFs have fallen in price as Chinese markets remain closed and their underlying holdings have not been traded during the extended holidays. The same is true for larger emerging market funds with significant exposure to Chinese equities, although the spread between their prices and their underlying net asset values ​​is less extreme.

For example, the


Vanguard FTSE Emerging Markets ETF

(ticker: VMO) posted a cumulative return of -3.82% through January 30, while its mutual fund clone,


Vanguard Emerging Markets Stock Index

(VEMAX), has posted a return of -3.22% since the start of the year. Both funds track the same index and have 37% of their assets in China.

Does this mean that ETFs are distorted vehicles because they fail to deliver a price that consistently reflects the last available NAV of their underlying holdings? Or does that mean that they properly become vehicles for price discovery when a market that experiences an unfavorable development like the coronavirus (or, failing that, a positive development) is closed for an extended period?

Matthew Bartolini, head of SPDR Americas Research at SPDR ETFs, said investors “should be pleased that the price of [their] the investment reflects the vision of the market. Indeed, the market, as it expresses its opinion through the price of the ETF, may be correct in saying that Chinese stock prices will fall the next time the Chinese markets open. The important point, however, is that the fund should reflect the current opinion of the market, whether the current opinion is correct or not.

After all, it may be that the underlying NAVs of an ETF are out of date and the most recent information and opinions are reflected in the prices of ETFs. If a NAV is so old, it might not make sense to look askance at a vehicle that reflects a more recent opinion.

Bartolini gave the example of someone making 401 (k) contributions on a Friday. Such a person investing in the Vanguard Mutual Fund will obtain the net asset value of its underlying securities. But if those prices are out of date and the market is right to anticipate lower prices on Monday, an ETF reflecting these current opinions and information will result in a lower price buy, benefiting the investor.

Again, assuming the market opinion as expressed in the ETF is correct and the Chinese markets open and close at significantly lower prices on Monday, the mutual fund will experience a one-day drop that the ETF had already incorporated over the past week or so. In this case, what looks like the ETF’s failure to value its underlying assets based on their last closing prices can be successful in avoiding the outdated pricing of the mutual fund.

It is tempting to view the behavior of ETFs in this case as similar to the behavior of closed-end funds. But Bartolini said that when closed-end funds don’t trade at the net asset value of their underlying securities, it’s because of differences in supply and demand for stocks.

It’s also true that ETFs don’t just reflect market sentiment. They use “fair value pricing” models that mutual funds with foreign stocks use to adjust prices when foreign markets are not open. Rich Powers, head of ETF management at Vanguard, said: “Mutual funds use models to connect open markets and how they expect markets to open on Monday.”

Powers conceded that one might expect more “wobble” in the efficiency of these models when foreign markets are closed over a period of one week than over a period of six hours. But the point is, ETFs have been using the same models that mutual funds have used for years.

Powers also said that the price of an ETF, as opposed to its net asset value, is the midpoint of the ETF’s bid and ask prices at market close. He wasn’t ready to say whether the 0.60 percentage point difference between the year-to-date price performance of the Vanguard ETF versus the Vanguard mutual fund (which exactly matches the return on value net asset value of the ETF) is unusually large. Barron calculated the difference between the annual price returns and the ETF’s net asset value returns over the past 10 calendar years to be 0.32 percentage points.

It’s a new world for mutual fund investors who are used to funds trading at net asset value and not serving as a vehicle for price discovery for other investors. But they may want to suspend their tendency to criticize ETFs too harshly for their structural differences with mutual funds. Bartolini said the current situation of non-NAV ETFs – when that NAV is old – is “a feature, not a bug” of ETFs. Investors should be happy with it, not worry about it.

Corrections and amplifications: The year-to-date return of the Vanguard Emerging Markets Stock Index fund is -3.22%. An earlier version of this article incorrectly stated that the cumulative return was 3.22%.

Write to John Coumarianos at john.coumarianos@barrons.com


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