Exchange Traded Funds or ETFs in India are fast becoming one of the popular investments for passive investors. If you are looking for pre-packaged investment portfolios at extremely low cost, ETFs are your port of call. With fund-houses launching ETFs right, left and centre, there are over 130 ETFs with about ₹4 lakh crore in investor assets. ETFs in India allow you to take passive exposure to three different asset classes - equity, debt and commodities. But what stumps most ETF newbies is the difference between ETF price and ETF Net Asset Value (NAV). Why is there a gap between NAV and market price? If there are two 'prices', which one is significant? These are some of the most common questions posed by investors. Here is a lowdown.
NAV, market price
An ETF usually tracks an index. One of the distinguishing characteristics of ETFs is that they can be bought or sold like a stock in the stock exchange. This differentiates ETFs from index funds, which also track an index. But unlike a mutual fund, which can be bought or sold only at the end of day price called NAV, an ETF can be traded live in the stock market, like a stock. This is why it is called an exchange traded fund.
The NAV of an ETF is the value of all the securities held by the ETF - such as shares or bonds and cash minus any liabilities such as Total Expense Ratio (TER), and divided by the number of shares outstanding. In case of gold ETFs, the valuation is based on the prices published by the London Bullion Market Association (LBMA). The daily LBMA AM (before mid-day) prices are taken by the fund-houses and converted into rupee terms after adjusting for customs duty and other costs such as Goods and Services Tax (GST) to arrive at the NAV.
The traded price of an ETF changes throughout the day like any other stock, as it is bought and sold on the stock exchange. For instance, the country's largest ETF, called SBI ETF Nifty 50, on March 8 had an NAV of ₹163.84 but traded at market prices between ₹161.34 and ₹164.45 on March 8.
Note that while ETF NAV is determined by the value of the fund's holdings, ETF market price at any point in time is also guided by the supply and demand in the marketplace for that particular ETF. For instance, UTI Nifty ETF, on March 9, saw a total traded quantity of 239 units on the BSE compared to 3,065 units for the same ETF on the NSE. So, even for the same security, the volume can be different across platforms, impacting its market price.
While market price is the rate at which you buy or sell the ETF units, it is the NAV that is used to measure ETF performance. Across fund-houses, NAV is the foundation of all performance display for ETFs. So, when you see 1-year, 3-year, 5-year of an ETF, or comparisons with benchmark indices, understand that they are done by using the NAV.
ETF premium, discount
In relatively calm markets, ETF prices and NAV stay close. However, when financial markets become more volatile, ETFs quickly reflect changes in market sentiment, while NAV may take longer to adjust - resulting in premiums and discounts. Even a popular ETF such as Nifty BeEs showed wide premium and discounts during the volatile market phase of March-April 2020. Some prominent gold ETFs in April 2020 traded at 5-10 per cent premiums.
On paper, the difference between the market price and the NAV of an ETFs isn't supposed to be more than 2 per cent. Indian ETFs have typically maintained a difference of about 1 per cent historically, though occasionally these differences can be quite large.
Do note that the more liquid the ETF i.e. larger is its asset base and higher trading volumes, the lower the premium/discount typically would be. In the industry, there are 25 ETFs that individually have less than ₹20 crore assets under management. Consequently, they also witness lower volumes.
Thanks to the creation/redemption mechanism in ETFs, deviations between ETF market price and its NAV tend to be short-lived usually. But do remember not all premiums and discounts quickly self-correct; some persist for a variety of reasons. For example, in order for authorised participants (AP) - who play the role of providing liquidity on the stock exchanges - to create or redeem ETF shares quickly, they need access to the underlying securities which may not always be possible. Also, for ETFs holding international securities, there could be a delay before the AP can finally access the underlying. This delay can lead to temporary premiums and discounts.
One should be prepared to deal with premiums and discounts while transacting in ETFs. Dig deeper before snapping up an ETF that is trading at a discount. This is because you may have to sell at a bigger discount when you eventually exit. Also, use limit orders that are set close to NAV to prevent buying at a large premium or selling at a large discount.