ETF Eulogy For iNAV

October 15, 2019

Ever since the “ETF Rule” dropped two weeks ago, a lot of smart minds have 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 (read: "SEC Passes Landmark 'ETF Rule'").

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 (read: "Understanding iNAV").

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 nails the iNAV coffin shut, no longer requiring issuers to calculate and disseminate it 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 iNAV in the grave.

How iNAVs Are Calculated

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 can end up with bad iNAVs 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 grow stale the second they're generated. In fact, for volatile markets, the consequences are far worse: A pickup in volatility is precisely the worst time for investors to be basing their trading decisions on expired data.

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

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