How Well Run Is Your ETF?

November 18, 2016

HEWJ And EWJ

You’d think the same would hold true for the iShares Currency Hedged MSCI Japan ETF (HEWJ). After all, BlackRock manages a huge suite of mutual funds. But you’d be wrong.

BlackRock didn’t always own iShares. It bought the business from Barclays, who had been managing it for Morgan Stanley, which designed ETFs to track MSCI’s indexes. iShares started out with every incentive to treat its ETFs like indexes. That means using 4:00 p.m. London currency strike times in its NAV calculations. This practice continues, even under BlackRock. HEWJ’s NAV is not fair-valued.

Instead, HEWJ’s tracking range is a victim of BlackRock’s cleverness. Let me explain.

BlackRock’s currency-hedged suite takes advantage of the enormous liquidity of iShares biggest international funds, to build a highly liquid, easily tradable currency-hedged version. They simply take an unhedged ETF like the iShares MSCI Japan (EWJ), and use it to provide exposure to the MSCI Japan index. They add in a currency hedge, and voila! A two-position portfolio that offers hedged exposure to the Japanese large and midcap equity markets.

We know that EWJ tracks its index well, with a median tracking difference of -0.28% and a range of only 0.40%, which is not bad for a basket of securities that don’t even trade during U.S. market hours. But here’s the thing: EWJ trades right up to 4:00 p.m. ET. EWJ’s price will reflect up-to-the-minute information, including movements in the Japanese yen and investor sentiment about the portfolio securities. EWJ’s market price is nothing like its NAV. That’s why EWJ’s premium/discount chart looks like this:

 

 

HEWJ’s NAV is calculated using the closing price of EWJ, not its NAV. That opens the door for EWJ’s “premium” or “discount” to flow through to HEWJ’s NAV. In general, EWJ’s premiums/discounts are not real, but simply a reflection of the staleness of EWJ’s NAV. HEWJ passes along the discrepancy.

In HEWJ’s case, the best way to assess tracking range is to proxy it via EWJ. For FJP, investors are simply out of luck, until the day that First Trust decides to provide nonfair-valued NAVs.

 

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