A primer on ETF valuation

See how an ETF's valuation is determined and which elements play a part in that calculation.

  • Wiley Global Finance WILEY GLOBAL FINANCE
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It's important to understand the different types of valuation mechanisms for ETFs, the nuances of each, and how to use them to get the best execution on your ETF order. Most ETFs track market indexes, and are passively managed. These are the ETFs that we are focusing on for this discussion. We begin with the calculation of the net asset value (NAV) of the funds and then explore discounts and premiums, cash amounts, and end with the calculation of the intraday indicative value (IIV).

The structure of the ETF is based on holdings transparency. One of the keys to being transparent is publishing all the numbers required to calculate the fair value of an ETF. There are 5 elements published daily that are involved in the valuation of an ETF:

  • Net asset value - This is the most recent official value of the ETF based on most recent market close
  • Total and estimated cash - The total and estimated cash amounts are the amount of excess cash in the fund; these numbers are used to calculate how much balancing cash will be required when doing a creation or redemption
  • Intraday indicative value - This is the calculation of the most recent value of the fund based on market prices of the underlying securities
  • Shares outstanding - The shares outstanding of the fund are how many shares have been issued and can change daily with creations and redemptions
  • Accrued dividends (certain funds only): These are dividends collected from all the companies in the index and normally paid to investors quarterly.

Trading tip

Add "ETF" to the ticker of the fund you are monitoring to view this data:

ETF ticker conventions Moniker Bloomberg Google Finance, Yahoo Finance, Reuters, others
Net asset value NV ETFNV ETF.NV
Intraday indicative value IV ETFIV ETF.IV
Total cash TC ETFTC ETF.TC
Estimated cash EU ETFEU ETF.EU
Shares outstanding SO ETFSO ETF.SO
Accrued interest DV ETFDV ETF.DV

Calculating net asset value

The net asset value (NAV) of an ETF is based off the most recent closing prices of the assets in the fund and the total cash in the fund that day. The NAV of the ETF is calculated by taking the sum of the assets in the fund, including any securities and cash, subtracting out any liabilities, and dividing that figure by the number of shares outstanding.

NAV =  (Assets − liabilities)/shares outstanding)

These data points, including what the fund is holding, are provided daily. This transparency frequently is touted as a major benefit of an ETF. Mutual and closed-end funds are not required to provide daily portfolio holdings. A mutual fund provides a daily NAV, but its holdings are released quarterly. A closed-end fund provides a daily or weekly NAV and usually releases quarterly holdings. In an ETF, you can see the assets and aggregate liabilities any time. This transparency helps prevent style drift in these products.

Cash and estimated cash

For the standard equity ETFs, there are 2 cash numbers published daily, the total cash (quote ticker TC) and the estimated cash (quote ticker EC). These are published as dollars per creation unit. For a fund showing a total cash number of $1,000 and having 250,000 shares outstanding with a 50,000-share creation unit size, the total amount of cash in the fund is $5,000. This is calculated as:

Cash in fund = shares outstanding/CU shares x total cash

Because the NAV of an ETF is reflected as a price per share, we use the total cash number converted to a per-share amount. We get this by dividing the total cash amount by the creation unit shares amount:

Cash per ETF share = total cash/CU shares

The total cash number is backward looking to ensure that creations and redemptions occur at NAV. When the fund is traded throughout the day, the estimated cash amount is used to indicate how much cash the fund will require for creations or redemptions. When calculating the intraday indicative value (IIV) or an estimated NAV (eNAV) of an ETF, the estimated cash number should be used. This number takes into account potential dividends, management fees, and other potential cash and portfolio changes in the basket. The next day, when determining the exact requirements of cash movement between the issuer and the AP, the total cash number is used.

Discounts and premiums

When an ETF’s market price is higher than its NAV, it’s trading at a premium; when it’s lower, it’s trading at a discount. Typically, premiums and discounts arise between an ETF’s NAV and its market price as a result of late market activity and will narrow on the following open.

Some circumstances can push an ETF away from its NAV at the end of the day, causing it to trade at either a premium or a discount compared to the basket. For example, if a large order came into the ETF at the very end of the trading day, and it’s too late or too large for the arbitrage functionality. Additionally, as the trading day ends, spreads typically widen to prevent the occurrence of exposures that will have to be held overnight. However, most discount or premium patterns for an ETF are short-lived.

Trading tactics

In general, avoid trading too close to the market's opening and closing times. If you trade the ETF too close to the market open, some of the fund's underlying constituents might not be trading yet. That's why you often see spreads tighten a few minutes after the open. Also, as the trading day draws to a close, ETF liquidity providers run the risk that they will not get completely filled in a basket and would have to carry overnight positions that are not perfectly hedged. This is why spreads widen near the close. There is more risk to providing liquidity at that time.

Calculating intraday indicative value

Although the NAV is important for the calculation of prior end-of-day valuation statistics, the intraday indicative value (IIV) takes you a step closer to the actual trading value of an ETF during the trading day. The IIV number provides an almost real-time indication of the value of the ETF’s assets throughout the trading day. It’s important to distinguish IIV because:

  • It goes by several different names.
  • At certain times during the day, it loses its relevancy because of trading anomalies as discussed previously.

The IIV, also sometimes known as the indicative net value (iNAV), is becoming a familiar term because it's used for quoting conventions. The ticker quoting convention is IV appended to the ticker: for example, ETFIV or ETF.IV or ETF IV, depending on the system.

The IIV typically publishes at a frequency of every 15 seconds, but lot can happen in 15 seconds, which that makes the number more relevant as a guide than a mandate. If the fund's price has moved slightly away, it’s probably a delayed IIV quote rather than an erratic movement in the ETF price itself.

Here’s an outline of how the IIV is calculated:

  1. Use the CU to get the correct share quantities for each stock in the basket
  2. Multiply the stock's last price by its number of shares in the CU
  3. Total the products to calculate total assets of the fund
  4. Divide this by the amount of shares per CU of the ETF
  5. Add to that the estimated cash value divided by the amount of shares per CU of the ETF

IIV = (Shares per each component stock x Last Price)/CU shares + estimated cash/CU shares

The IIV is the implied value of the ETF as calculated by the most recent trading prices of all the stocks in the basket. This value is calculated completely independently of the actual trading price of the ETF in the secondary marketplace. However, in a US-listed ETF with a basket of domestic stocks underlying, those 2 independently generated values should trade in parity with one another because of the open conversion between the basket and the ETF.

This is one of the core functionalities of the creation and redemption mechanism of the product wrapper and the one responsible for eliminating discounts and premiums. In many high-volume ETFs, a quote for the IIV and a quote for the ETF should be at parity with each other. Differences could be because of the time lag and other occasional structural nuances. Since stock (and therefore ETFs) trade in microseconds, a lot can happen in between 2 separate 15-second quotes. Professional traders don’t use published IIVs. Instead, they’re calculating their own IIVs based on real-time quotes in the underlying baskets. They see their own IIV calculation in real time so they can act on pricing at the same frequency as their competitors.

Next steps to consider

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