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Valuation of ETFs

  • Wiley Global Finance WILEY GLOBAL FINANCE
  • Exchange-Traded Funds
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The structure of an ETF is based on holdings transparency. One of the keys to being transparent is publishing all of the numbers required to calculate the fair value of an ETF every day. Six elements involved in the valuation of an ETF are published every day:

  1. Net asset value (NAV)
  2. Intraday indicative value (IIV or IOPV)
  3. Total cash
  4. Estimated cash
  5. Shares outstanding
  6. Accrued dividends (certain funds only)

NAV

The NAV of an ETF is a daily calculation that is based off the most recent closing prices of the assets in the fund and an actual accounting of the total cash in the fund at the time of calculation. This gives the fund a standardized value that can be compared to other funds for performance statistics and accounting. The fund world is based on comparative statistics, so uniform reporting was critical in the development of ETFs.

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 by the number of shares outstanding.

NAV = (Assets - Liabilities)/Shares Outstanding

All of these data points are provided on a daily basis, including exactly what the fund is holding. This transparency frequently is touted as a major benefit of an ETF. Mutual and closed-end funds are not required to provide portfolio holdings on a daily basis. A mutual fund provides a daily NAV but holdings are released quarterly. A closed-end fund provides an NAV either daily or weekly with holdings released usually quarterly. In an ETF, you are able to see the exact assets and aggregate liabilities of the fund at any time. This is also a factor which has worked to prevent against style drift in the products.

The easiest way to calculate the NAV of an ETF is to use the creation unit (CU) and total cash published daily.

NAV = sigma-17(Shares per each component stock x Last Price)/CU Shares+Total Cash/CU Shares

The NAV of an ETF is represented in share price terms. This is why you would be dividing the asset totals by shares outstanding and the creation unit calculations by the creation unit share amount.

Intraday Indicative Value

The IIV or the IOPV is the calculation of the most recent value of the fund based on market prices of the underlying securities. Although the NAV is important for the calculation of prior end-of-day valuation statistics, the IOPV is critical for bringing you a step closer to the actual trading value of an ETF during the trading day. It is important to distinguish what this number actually is for two reasons:

  1. It goes by several different names.
  2. At certain times during the day, it loses its relevancy because of trading anomalies.

The IIV is also sometimes known as the indicative net asset value (iNAV). The five steps for calculating the IIV are:

  1. Use the CU to get the proper share quantities for each stock in the basket.
  2. Multiply the last price of each stock by its representative share amount in the CU.
  3. Sum 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 = sigma-17(Shares per each component stockXLast Price)/CU Shares+Estimated Cash/CU Shares

    This value is calculated completely independently of the actual trading price of the ETF in the secondary marketplace. However, in a U.S.-listed ETF with a basket of domestic stocks underlying, those two 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.

Cash

For the standard equity ETFs, there are two cash numbers published daily, the total cash and the estimated cash. The quoting ticker conventions are TC and EU respectively. These are published as actual amounts in 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 would be calculated with the equation:

Cash in Fund = Shares Outstanding/CU SharesXTotal  Cash

Since the NAV of an ETF is reflected as a price per share, you will use the total cash number converted to a per-share amount. This is arrived at 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 being traded throughout the day, the estimated cash amount is used to give the AP an idea of how much cash the fund will require for the creation or redemptions. When calculating the 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. Then the following day, when determining the exact requirements of cash movement between the issuer and the AP, the total cash number is utilized.

Shares Outstanding

The shares outstanding of the fund are how many shares have been issued and can change daily with creations and redemptions.

It is 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. For U.S.-listed ETFs with underlying constituents that are trading at the same time as the fund, the IIV should be on or close to the ETF price, and under normal circumstances premiums and discounts will be arbitraged away. The IIV is a base of almost real-time valuation for the ETF, which is unique to the ETF wrapper, as mutual funds and closed-end funds are priced either once a day or periodically throughout the month.

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Article copyright 2011 by David J. Abner. Reprinted and adapted from The ETF Handbook: How to Value and Trade Exchange Traded Funds with permission from John Wiley & Sons, Inc. The statements and opinions expressed in this article are those of the author. Fidelity Investments® cannot guarantee the accuracy or completeness of any statements or data. This reprint and the materials delivered with it should not be construed as an offer to sell or a solicitation of an offer to buy shares of any funds mentioned in this reprint.
The data and analysis contained herein are provided "as is" and without warranty of any kind, either expressed or implied. Fidelity is not adopting, making a recommendation for or endorsing any trading or investment strategy or particular security. All opinions expressed herein are subject to change without notice, and you should always obtain current information and perform due diligence before trading. Consider that the provider may modify the methods it uses to evaluate investment opportunities from time to time, that model results may not impute or show the compounded adverse effect of transaction costs or management fees or reflect actual investment results, and that investment models are necessarily constructed with the benefit of hindsight. For this and for many other reasons, model results are not a guarantee of future results. The securities mentioned in this document may not be eligible for sale in some states or countries, nor be suitable for all types of investors; their value and the income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates or other factors.
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