Diving into the net asset value pool of ETFs and mutual funds

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By David Mann, Global Head of Capital Markets Exchange Traded Funds (ETFs), Franklin Templeton

With many mutual funds converting to exchange-traded funds (ETFs), the combination of ETF trading and net asset value is gaining more and more attention. David Mann, Head of Global ETF Capital Markets, dives deep into the matter.

My original blog (ETF Capital Markets Corner) has been around since 2016. For those who have been reading from the very beginning, you are well aware of how much ink has been spent discussing and debating some of the misconceptions surrounding Exchange Traded Funds (ETFs). ) liquidity.

I like to think that this audience – and investors more broadly – ​​are now more comfortable trading new funds, regardless of size or trading volume.

One of the points I made when pointing out the flaws of using average volume as a liquidity indicator was that ETF net asset value (NAV) trades do NOT count in volume calculations. officials. (See my previous articles, When Volume Doesn’t Tell the Whole Story and Revisiting (Again!) The Problems of ETF Volume).

Not only does the trading volume ignore how much the ETF’s underlying basket is trading, it also ignores a potentially large pool of block trades executed in the NAV markets.

These posts lacked a broader discussion of the NAV trades themselves. It’s a topic that’s starting to get a little more attention, especially now that mutual funds have started converting to ETFs and mutual fund investors are used to trading at net asset value.

Before we dive into the different flavors of ETF NAV trading, let’s first look at why investors love ETFs (and why mutual funds convert to them). I think these are my top four:

  • Tax efficiency
  • Low costs
  • Transparency on a daily basis
  • Intraday trading

For the first two reasons, all other things being equal, you would certainly prefer your investment to be tax efficient and inexpensive rather than inefficient and tax costly.

For the last two, there’s a real possibility that you’ll shrug off one or both. For daily transparency, I’m sure there are a lot of investors who don’t check portfolio holdings every day. For many long-term investors, the value of intraday trading is minimal at best.

We can apply this last point to mutual fund investors, especially those who might be entering the world of ETFs for the first time. Mutual fund investors are not concerned with intraday trading because that is not how they work! We often say that ETFs are like mutual funds, except that you can trade at any time of the day. But no one is saying you have to exercise this option.

So, for this effort, let’s discuss how we can make the ETF trading experience just like the mutual fund investing experience. My basic understanding of buying a stock mutual fund:

  • Regardless of the time at which the order is submitted during the trading day, the investor obtains the net asset value of the day.
  • For mutual funds that hold US stocks, this net asset value will be based on the closing price of those US stocks.
  • For mutual funds with international holdings, there may be an adjustment to the fair value of those international stocks when calculating the net asset value of the fund.

Intraday ETF trading is simply a mix of these three elements calculated continuously throughout the day. To understand an ETF’s intraday price, start with the value of the underlying stock, then adjust for closed international stock markets if necessary (in the ETF world, we call this “price discovery”). “).

For an ETF to have that mutual fund feel, investors want that last closing price no matter what time they submit their order during the trading day. To do this, investors must use a type of market order at the close (MOC) to buy or sell at the last closing price.

So, for mutual funds that might make sense in an ETF wrapper, it is imperative that the ETF issuer works with both listing exchanges and ETF market makers to ensure that the MOC order works as expected.

I talked about auction close at the 2018 Market Structure Madness event, and these types of orders can work really well when ETF market makers are prepared for it.

The end result (of the day) is that instead of buying a mutual fund for a certain amount of dollars, you will buy a certain number of shares of an ETF using the MOC order. For advisors not as familiar with ETF trading, their overall experience should be the same.

One last point before concluding this discussion. The MOC order is different from trading at NAV. NAV trades (as the name suggests) are generally larger trades priced based on the official NAV of the ETF.

As a rule, the official net asset value is not known until very late on the trading day. So the NAV trades are printed before the market opens the next trading day, which, going back to my previous comment, is why they don’t count towards the ETF’s official trading volume.

MOC and NAV transactions have their uses for all investors. However, for current mutual fund investors taking their first step into ETFs, it’s probably the MOC order that will make them most comfortable.

What are the risks ?

All investments involve risk, including possible loss of capital. The value of investments can go down as well as up, and investors may not get back the full amount invested. Generally, those that offer the potential for higher returns come with a higher degree of risk.

For actively managed ETFs, there can be no assurance that the manager’s investment decisions will produce the desired results.

ETFs trade like stocks, their market value fluctuates and may trade above or below the net asset value of the ETF. Brokerage commissions and ETF expenses will reduce returns. ETF shares can be bought or sold throughout the day at their market price on the exchange on which they are listed. However, there can be no assurance that an active trading market for ETF Shares will develop or be maintained or that their listing will continue or remain unchanged. Although ETF shares are tradeable in secondary markets, they may not trade easily in all market conditions and may trade at significant discounts during times of market stress.

Original post

Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.

About William G.

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