Exchange-traded funds typically don't stray far from their net asset values (NAVs). One of the greatest strengths of the ETF structure, the creation/redemption mechanism, makes it so the price of a fund stays close to the value of its underlying assets.
Usually, this process works flawlessly. Out of the nearly 2,000 ETFs on the U.S. market today, 83% of them are trading within 1% of their NAVs, while 94% of them are trading within 2% of their NAVs. For various reasons, the others have larger gaps between their market price and the value of their assets. Sometimes, those gaps are substantial.
New Creations Suspended
Take the DB Commodity Double Long ETN (DYY). The market price for this exchange-traded note is a whopping 97.3% above its NAV. The reason for this is simple: Deutsche Bank suspended creations of the notes indefinitely in 2012. Without the ability to create new units, the mechanism that would normally keep DYY trading close to its NAV is broken, and there's no way to arbitrage-away the massive premium.
It's not unheard of for ETN issuers to suspend creations. It's happened regularly over the years, and is something investors in these products should keep a close eye on.
The iPath Bloomberg Natural Gas Subindex Total Return ETN (GAZ), which has a 10.8% premium, is another ETN where creations were suspended, resulting in a market price well above NAV.
Fortunately, not too many investors own these flawed products. There are 45 exchange-traded products on the market that have suspended creations, but most are tiny, with only a few million dollars in assets each.
Stale Market Price Or NAV
Another reason that investors might see big discrepancies between a product's share price and its NAV is due to lack of trading. For example, the iPath Short Enhanced MSCI Emerging Markets Index ETN (EMSA) last traded in 2015, at a price of $110/share.
Since then, its NAV has dropped to around $57, seemingly creating a premium of 92.7% based on the last market price. But that premium isn't "real." Any new market transactions would likely happen much closer to the NAV; it's just that interest in the $1 million ETN is so low that no trades have taken place in more than a year.
In the case of EMSA, the market price is "stale," while the NAV continually updates, creating a perceived premium. In other cases, the opposite occurs. For funds holding securities that trade in a different time zone, such as international equity ETFs, the NAV may be temporarily stale.
For instance, stocks in the U.K. stop trading at 12:30 p.m. Eastern time, but U.S. stocks and ETFs keep trading until 4:00 p.m. For the iShares MSCI United Kingdom ETF (EWU), which holds a basket of U.K. equities, the NAV will be struck at 12:30 p.m., when U.K. markets close, but EWU will continue to trade for another few hours. In those few hours, the fund's trading price could deviate from its NAV.
Bond ETF Discounts
Of course, deviations from NAV can take place both on the upside, creating a "premium," as well on the downside, creating a "discount." The latter is a bit rarer because it's more unusual to see an issuer suspend redemptions than it is to see it suspend creations.
Still, there are a handful of products trading with sizable discounts, mostly due to inactive trading. The iPath Long Enhanced MSCI Emerging Markets Index ETN (EMLB) and the Barclays Return on Disability ETN (RODI) look like they're trading at discounts of 36.9% and 12.9%, respectively, but that's only because they're so infrequently traded (creating the "stale market price" phenomenon described above).
One larger product trading with a notable discount is the AdvisorShares Peritus High Yield ETF (HYLD). Currently it has a 3.1% discount―not huge, but enough to catch one's eye. Bond ETFs have been known to sometimes trade at discounts to their NAVs due to the difficulty of pricing bonds and the lack of liquidity in some bond markets, especially during times of stress.
A discount in a bond ETF doesn't mean a product is bad per se; it's simply a reflection of the liquidity conditions of the fund's underlying bond portfolio.
For investors in bond ETFs―and exchange-traded products of all stripes―large discounts and premiums are a caution sign. In those cases, it's a good idea to take a look under the hood to see if there's any issues with a product, such as a suspension of the creation/redemption mechanism, a lack of liquidity or anything else that may impact returns.
For a list of the 10 ETFs that currently have the largest premiums and discounts, see the tables below:
|DYY||DB Commodity Double Long ETN||97.3%|
|EMSA||iPath Short Enhanced MSCI Emerging Markets Index ETN||92.2%|
|GAZ||DB Commodity Double Long ETN||23.9%|
|HAKD||Direxion Daily Cyber Security & IT Bear 2X Shares||9.0%|
|SBV||iPath Pure Beta S&P GSCI-Weighted ETN||6.3%|
Contact Sumit Roy at [email protected]