Eulogy For iNAV

February 01, 2020

When the “ETF Rule” finally dropped last year, a lot of smart minds spilled a lot of ink digging into its juiciest parts. No more exemptive relief! Custom baskets! Daily portfolio transparency! It’s a veritable grab bag—albeit a nerdy one—of goodness for investors and the industry alike.

Yet one item in the ruling has mostly gone under the radar, and that’s the de facto death of iNAV.

“iNAV,” or intraday net asset value (also intraday indicative value, “IIV”; or indicative optimized portfolio value, “IOPV”), is an intraday estimate of an ETF’s net asset value, based on the current trading prices of the fund’s constituent securities.

Conceived as a way to give investors real-time transparency into their investments, iNAVs have been a requirement in exemptive relief orders since the very beginning of ETFs. With the new ETF Rule, however, the SEC now effectively nailed the iNAV coffin shut, and will no longer require issuers to calculate and disseminate iNAV as a condition of launching an ETF.

If the iNAV was so great, why get rid of it?

The obvious answer is: It wasn’t really that great. Despite its potential, the humble iNAV never quite achieved the transparency it intended, and as such, never truly caught on with investors. Perhaps the only surprising aspect about the SEC’s decision is how long it took to put the iNAV rule in the grave.

Calculating iNAVs
Originally iNAVs were conceived as a way to help investors trade ETFs, providing greater transparency to an ETF’s most up-to-date fair value throughout the trading day.

That’s a noble goal, because an ETF’s NAV changes any time the values of its underlying securities change. And since ETFs trade whenever markets are open, their NAVs are perpetually in flux (as compared to mutual funds, which calculate NAV once per day, after the market closes).

To calculate an iNAV, you take a representative basket of the ETF’s current holdings; tally up the market value of all the shares of all the securities in that basket, based on the shares’ last trading price; then divide that total by the number of ETF shares used for the representative basket (usually a creation unit … and there’s a bit more to it than that, but that’s the basic gist).

iNAVs are updated and published every 15 seconds throughout the market day, meaning investors could use them to determine whether an ETF was currently trading at a premium or discount, revealing opportunities for arbitrage and alpha generation.

But an iNAV’s usefulness only goes as far as the accuracy of the underlying data going into its calculation. Though the math is simple, the true market value of an ETF’s underlying securities isn’t always as easy to come by.

Limitations Of iNAV
Consider a U.S.-listed ETF that holds Japanese stocks. Since Tokyo is on an opposite time zone to New York, the Tokyo Stock Exchange will never be open at the same time as U.S. stock exchanges. That means the last trading price for the stocks in this ETF will be based on yesterday’s closing price, making the iNAV calculation inherently stale. (The same would be true for its end-of-day NAV calculation, too.)

The same holds for, say, bond ETFs holding smaller, niche bonds that don’t trade for days, sometimes even weeks at a time (not uncommon in junk and munis). In those cases, the iNAV for that fund would still update every 15 seconds, but at best, it would be based on a bond pricing service’s best guesses; at worst, it would be meaningless or even misleading.

It’s not just “weirder” funds that could end up with bad iNAV’s either. In fast-moving and volatile markets, when trades execute every hundredth or even thousandth of a second, 15 seconds might as well be a lifetime, and iNAVs would grow stale the second they were generated. In fact, for volatile markets, the consequences could be far worse: A pickup in volatility is precisely the worst time for investors to be basing their trading decisions on expired data.

In ETF.com’s comment letter to the SEC about the ETF Rule, it noted that iNAV data was inaccurate for a whopping 80% of all ETFs. So if this metric doesn’t work in slow markets and doesn’t work in fast markets, how exactly was iNAV supposed to be helpful?

Sophisticated Investors Build Their Own
But it’s not like the limitations of iNAVs were some big industry secret. Most liquidity providers and authorized participants already knew about them; and when making trading decisions, they long relied on their own real-time, in-house calculations of up-to-the-second “fair valuation.”

Fair valuation is calculated much the same way as iNAV, but in the case of underlying securities that aren’t currently trading, a proxy is used instead. For example, in our previous Japan example, an AP might use Nikkei 225 index futures contracts or other broad stock market derivatives, or even competing ETFs, to help calculate the Japan ETF’s fair value when the NYSE is closed.

All this means is that sophisticated investors were already basing their decisions on whether or not to trade an ETF using their own proprietary best guesses. They weren’t using iNAV as anything more than a “secondary or tertiary check” on their own numbers—and those are the SEC’s words, not ours.

Unhelpful For Retail Investors
That said, iNAVs could still have proved useful for smaller retail investors and advisors who lacked the resources to calculate their own fair valuation estimates. But it didn’t.

In its ruling on the ETF Rule, the SEC noted that even in the narrow case where they might be useful, actually accessing an ETF’s iNAV via free, publicly available means was never an easy task. ETF issuers don’t regularly publish this information on their fund pages: Many just publish a ticker that investors can look up to get more data—or, more often, nothing at all.

Nor do free financial websites make iNAVs easy to find. ETF.com doesn’t publish the data, and other sites that do provide it often delay its publication by up to 15 minutes.

Given that a 15-second delay is long enough for prices to become obsolete in some markets, iNAVs that are published every 15 minutes would be stale to the point of uselessness, and ultimately, the potential harm this could cause retail investors was one of the SEC’s main motivations for no longer requiring iNAVs.

Many commenters argued—as did the SEC—that daily portfolio disclosure would be of much more use in determining ETF fair values intraday. Market participants could then use that information to calculate their own in-house data.

That doesn’t help retail investors much, but then again, neither does iNAV.

 

 

 

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