Numbers Don't Lie in ETF/NAV Debate
Over the past two weeks, much has been made about ETFs and the drift away from underlying net asset values that occasionally occurs with these products.
Some of the coverage of this issue, mainly from those publications devoted to ETFs or from those with intimate knowledge of the asset class, has been important, eye-opening and solid.
Unfortunately, a day or two of a microscopic percentage of the total U.S. exchange-traded products universe trading at noticeable discounts or premiums to NAV sparked alarmist, downbeat coverage of the issue that backhandedly sought to cast ETFs in a sour light. Hey, when not one, but two financial news organizations bring up the three-year old Kauffman Foundation criticism of ETFs without mentioning at least two important facts about that report, readers of those articles are being treated to only part of the story.
As for that report, which has since been widely discredited, just remember that Tom McDonnell, president and chief executive officer of the Ewing Marion Kauffman Foundation, used to run a company called DST Systems (NYSE: DST). In fact, he ran DST when the Kauffman report was published. DST provides "distribution support systems for the United States and international mutual fund companies," among other businesses, according to Yahoo Finance. That was not mentioned in the recent stories that highlighted the Kauffman report.
There are other problems with the ETF/NAV "debate." A financial adviser quoted in a Bloomberg piece out Monday said this: "I don't think most people have any clue that the prices they're paying or selling at can veer significantly from NAV."
That might be true. Alright, it probably is, but it does not have to be. Nor do investors, retail or professional, need to be scared about ETFs frequently veering away from NAV because the numbers paint a different picture.
For the purposes of this exercise, we examined ETFs tracking three different asset classes: U.S. equities, bonds and emerging markets stocks. We focused on two of the four largest issuers: BlackRock's (NYSE: BLK) iShares and Invesco's (NYSE: IVZ). Add up the ETFs issued by those companies and the total is over 300, roughly 20 percent of the total U.S. exchange-traded products universe. Here is what we turned up in terms of NAV premium and discount gaps.
For iShares, we started with the iShares U.S. Medical Devices ETF (NYSE: IHI), an ETF that though it is not small with $388.4 million in assets under management, does not get a lot of attention or at least not not enough for some experts that associate popularity with performance.
Although IHI does not even have average daily volume of 73,000 shares, most of its top-10 holdings, which account for 62.5 percent of the ETF's weight, have decent (at worst) volume. Fact: During every single trading day of the second quarter, IHI never traded at anything more than a 0.5% discount or premium to its NAV. Same goes for the previous three quarters.
Next, there is the iShares Emerging Markets Local Currency Bond ETF (NYSE: LEMB). The combination of emerging markets denominated in local currencies would surely imply liquidity issues and major discounts or premiums to NAV, right? Not really. The widest premium LEMB saw in the second quarter was 1.55 percent. Including the second quarter, the most elevated premium LEMB saw over the prior four quarters was just under two percent.
In the first quarter of this year, LEMB spent nearly every trading at a premium of one percent to 1.5 percent of its NAV, according to iShares data. Sorry folks, that is not much to be alarmed about.
The iShares MSCI Philippines ETF (NYSE: EPHE) is our final iShares selection because this fund has spent more time in the spotlight for all the wrong reasons recently than investors that own it care to remember.
Bloomberg correctly observes that EPHE "swung from a 4.7 percent premium to a 6.1 percent discount and back to a 2 percent premium in the space of nine trading days through June 25." The other side of the coin is that iShares data show the largest discount in the previous three quarters was just 1.99 percent and that EPHE. Said differently, in roughly 180 trading days comprising the third and fourth quarters of 2012 and the first quarter of 2013, EPHE never even traded with a two percent premium.
PowerShares data highlights the relationship of its ETFs to NAV in a different way by showing the percentages by which the mid-point of an ETF's bid/ask spread exceed NAV or are discounted. We chose the The PowerShares DWA SmallCap Technical Leaders Portfolio (NYSE: DWAS), an ETF that has recently outpaced some of large small-cap rivals.
In theory, the small-cap space could be fertile ground for wide spreads and liquidity issues. However, in the 113 days DWAS traded in leading up to the start of the second quarter, there were only four occasions in which the bid/ask mid-point was noticeably above NAV and only two times did the number exceed two percent. Only one noticeable discount to NAV was seen over the same period, according to issuer data.
There has been plenty of ongoing chatter about liquidity and premium/discount spreads in the high-yield bond market. And yes, in times of market stress, bond funds, but on most days, most bond ETFs are trading within tolerable margins of their NAVs.
In 2012's 250 trading days, the bid/ask mid-point on BKLN never exceeded one percent and on 100 occasions its was just 0.5 to 0.99 percent above NAV. That did not happen at all in the first quarter, nor does BKLN have a history of trading at wide discounts.
The iShares MSCI Emerging Markets Index Fund (NYSE: EEM) was lambasted for one day where the ETF traded at a significant discounted to its NAV. As has been noted in the days since then, some veering away from NAV happens with emerging markets ETFs, particularly multi-country funds, because most of the countries' markets represented within the fund are closed while U.S. markets are open.
This is the case with the PowerShares FTSE RAFI Emerging Markets Portfolio (NYSE: PXH). China, Brazil, Taiwan and Russia combine for nearly two-thirds of PXH's country weight. PXH traded at a premium or discount to the mid-point of its NAV in about one of every three trading days last year and at a premium 16 times in the first quarter.
However, there was only occasion of PXH trading at a premium of two percent or more and only five times did the ETF trade at a discount of one to 1.99 percent.
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