ETF Intraday Net Asset Value Proxies
When trading began in the first ETF introduced in the United States (the S&P 500 SPDR launched in 1993), the Securities & Exchange Commission (SEC) required that the sponsors of the SPDR arrange for dissemination of an intraday share value proxy for the SPDR at 15-second intervals. These proxies are usually called indicative optimized portfolio values (IOPVs). The requirement for publishing these values was extended to every domestic equity ETF launched since 1993 and, with modifications, to ETFs holding foreign equities, fixed-income instruments and other financial instruments.
In spite of improvements in trading data calculation technology and the introduction of ETF portfolios that hold infrequently traded securities, calculations of these intraday value proxies are still based on the most recent trade of each portfolio component. Matt Hougan discusses the inadequacy of last-sale value proxies in an article scheduled to appear in the July 2009 issue of ETFR. These intraday value proxy calculations are made and/or disseminated by the National Securities Clearing Corporation (NSCC) and other service providers to “support” intraday trading of ETFs.
Professional ETF traders and market makers do not use the “official” every-15-second proxy value calculations to help them determine their ETF bids and offers. Professionals develop their own valuations or subscribe to real-time ETF value calculations based on contemporary bids and offers rather than last sales. The fact that they do not use the free IOPV does not mean that these professionals lack faith in the NSCC’s ability to calculate correct values. The simple facts are that the last sale is not a reliable indicator of contemporary values in most market situations, and the 15-second interval between valuations is too long for the values to be useful to a trader.
Because an ETF is a derivative security, its current value changes every time the value of any component of the ETF portfolio changes. The ETF value proxies used by professional traders are calculated from the midpoint of the bid and offer for each position in the ETF portfolio. Sometimes the value calculations made by and for professionals use the size of bids and offers and the pattern of “changes” to forecast short-term trends. Figure 2 illustrates how a naive investor might attempt to use the “free” intraday proxy information to develop a bid or offer for ETF shares.
In Figure 2, the latest IOPV is represented by a dot at the beginning of each of the five 15-second intervals illustrated. Investors might place limit orders at prices close to the most recent per-share value proxy. Columns A through E illustrate how bids and offers entered at equal distances, respectively, below and above a sequence of these every-15-second net asset value (NAV) proxy calculations might become transactions—but not always the transaction that the investor entering the order hoped to achieve. An offer to sell the ETF’s shares slightly above the proxy value posted at the beginning of time interval A would probably be lifted as the fund portfolio value rose during intervals A and B. That offer was below the changing per-share proxy value by the time that value was updated at the beginning of interval C—less than 30 seconds after the order was entered. The offer was also below the likely bid in the market at that time. Of course, some of the last-sale prices used to calculate each 15-second proxy might be more than a few minutes old at the time the calculation was made. Using the free 15-second values can be costly, but even if investors had access to proxy values based on every-15-second midpoints of bids and offers and could enter orders as soon as the value was published, a lot can change before or shortly after the next proxy value is published.