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Hougan: Ban iNAVs For ETFs

June 24, 2013
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Related ETFs

Ticker Fund name
EWHiShares MSCI Hong Kong
IVViShares Core S&P 500
Related ETF Lists
Asia-Pacific ETFs, Large Cap ETFs

Determining an ETF’s intraday value is of no help for international-related funds.

The only thing worse than no information is bad information, and for most ETFs, iNAVs are downright misleading. They should be banned.

The intraday net asset value, or iNAV—also known as the indicative optimized portfolio value (IOPV), indicative intraday value (IIV) or intraday portfolio value (IPV)—is a number born of the best intentions.

By law and by practice, ETF providers are generally required to publish an iNAV every 15 (or 60) seconds of every trading day for every ETF they offer. The Securities and Exchange Commission explained in a recent release:

The iNAV is intended to approximate the fair value of the securities held in the portfolio by the ETF and should closely represent the value of the fund during the trading day.

That sounds great; unfortunately, it isn’t remotely true for at least half of the ETFs on offer.

This became a flash point recently thanks to the flurry of incredibly bad financial journalism surrounding ETF trading activity last week. Good reporters at reputable news outlets like the Financial Times took that SEC definition at face value and wrote sentences like:

ETFs track baskets of underlying assets, such as emerging-market stocks or municipal bonds, but discounts widened sharply on Thursday as dealers struggled to keep up with the sell orders ... For example, the share price of the iShares MSCI Emerging Markets Index fell to a 6.5 per cent discount to the underlying asset value.

That sounds scary. But as anyone with a solid understanding of how ETFs work knows, that statement is effectively meaningless.

Let’s see why.

Domestic Equity ETFs

Let’s take the one example of where iNAVs work exceptionally well: domestic equity ETFs.

Imagine an extraordinarily simple ETF like the iShares S&P 500 ETF (NYSEArca: IVV). IVV’s investment mandate is simple: Hold all the stocks in the S&P 500 Index, in the exact proportions of the index.

Each morning, iShares publishes what’s known as the “creation basket” for IVV. This is the list of securities that an authorized participant must purchase and deliver to iShares to “create” more shares of the fund. This basket is generally identical to the securities that the fund wants to hold, which are, of course, all of the securities in the S&P 500 Index.

As a condition of getting the exemptive relief it needs from the SEC to run the fund in the first place, iShares must list with an exchange that will publish an iNAV every 15 seconds of every trading day. A third-party calculation agent does this, and the work is extraordinarily simple: Take all the securities in the ETF, look at the last price they traded at, add it all up, divide by the number of shares outstanding, and calculate the iNAV.

This offers a real-time view of the fair value of IVV, and one would expect IVV to trade in line with its iNAV almost all of the time. In fact, it does.

This is great system: Investors get a real-time view of fair value, so they know if they are over- or underpaying for IVV when they push “buy.”


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