ETF Performance Valuation

Commodities, Investing & Retiring, Mutual Funds, Stocks

Exchange-Traded Funds (ETFs) can be tricky to value, because they have the pricing characteristics of both mutual funds and stocks.

ETF’s, like mutual funds, contain a market basket of shares of different companies, and so their valuation is calculated as a Net Asset Value (NAV) which gives you the collective valuation of the underlying holdings of the ETF.

The formula itself is simple. NAV is the sum of all the assets in the fund minus the fund’s liabilities, and that number is in turn divided by the number of outstanding shares to keep things on a per share basis. The NAV is typically estimated by calculations based on the price mixtures of the securities.

To come up with a meaningful per share basis, NAVs are calculated using “Creation Units” instead of outstanding shares. Creation Units (CUs) are large blocks of shares (in the tens of thousands) that make up the “denomination” of the ETF. It establishes the relationship between ETF shares and the mixture of the underlying securities. Think of them as a form of conversion factor between units.

Since the funds contain cash assets as well as securities, these have to be taken into account as well. This adds another term to the NAV calculation. Liabilities are subtracted from the cash number.

After these adjustments, the NAV calculation looks like this:

NAV = ((summary of the shares per each component stock)(Price for that stock))/CU shares + (total cash)/CU shares.

Fortunately, you do not have to calculate the NAV yourself. It is issued for ETFs at the end of each trading day, just as with mutual funds, and is available on many sites.

Let’s switch gears and consider the comparison between ETFs and stocks. ETFs are like stocks in that they trade constantly on exchanges, and thus the “true” NAV at any point is time is changing throughout the day (unlike mutual funds).

If you are a buy-and-hold investor in ETFs, a daily NAV update may be good enough for you. However, if you are a more active trader, trading off of a NAV valuation means that you are trading on “old” information, and you may overpay for an ETF based on this information. You know the immediate price, but you don’t know the immediate value of the underlying securities, therefore you cannot tell if the ETF is temporarily overpriced.

Enter the Indicative Net Asset Value (iNAV), sometimes called the Intraday Indicative Value (IV). This value is updated every 15 seconds to reflect the value of the underlying securities in as close as possible to real time.

The formula for the iNAV is the same, except that the price reflects the current price instead of the closing price, and the total cash is estimated since the cash value is published daily.

Again, fortunately for you it is not necessary for you to calculate the iNAV. It is available on the stock ticker, usually listed as an ETF.IV or some close variation.

By comparing the NAV/iNAV and the current market price and bid/ask spreads, you can get a feel for whether an ETF is overvalued – assuming your information is as current as you need it to be.

Keep in mind that foreign exchanges will be trading when the domestic exchanges are not. Events that would affect the ETFs price overnight have not yet been incorporated into the price of the securities, leading to gaps in price and NAV. You have to dig into whether the discrepancy is warranted by the events.

You probably will never have to calculate a NAV or an iNAV for yourself, but knowing where they are found and how to use them will help you to make wise ETF investments. Just be thankful somebody else is doing the number crunching for you.

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