ETF Market Price vs. NAV: Understanding the Differences

Exchange-Traded Funds (ETFs) are a popular investment vehicle that offers liquidity, diversification, and transparency. One of the key concepts that investors need to understand is the difference between the ETF’s market price and its Net Asset Value (NAV) to make informed investment decisions. This article explains the intricacies of these concepts, how they are calculated, and their importance to investors.

What is an ETF?

An ETF is a type of investment fund that is traded on stock exchanges, much like stocks. For a detailed overview of ETFs and how they work, refer to this article on “What is an ETF and How They Work.”

What is the ETF Market Price?

The market price of an ETF is the price at which its shares can be bought or sold on exchanges during trading hours. ETFs trade like stocks, so their market price fluctuates throughout the day as buyers and sellers interact and execute trades. When demand for an ETF’s shares increases, the market price typically rises. On the other side, when supply is higher than the demand, the market price usually falls.

What is the Net Asset Value (NAV) and What is it Used For?

The Net Asset Value (NAV) of an ETF represents the per-share value of the fund’s assets minus its liabilities. The NAV is calculated at the end of each trading day and serves several important functions:

  • Performance Measurement: Investors use the NAV to gauge the performance of their ETF investments.
  • Transparency: Daily disclosure of NAV provides transparency about the value of the ETF’s underlying assets.
  • Comparison: NAV allows for easy comparison with other funds and benchmarks.
  • Accounting: The NAV is used to report dollar figures for accounting purposes

Calculating the NAV of an ETF

The NAV of an ETF is calculated by subtracting any liabilities from the total value of all the fund’s assets, including cash, and then dividing the result by the number of outstanding shares.

NAV = All assets minus liabilities divided by Number of outstanding shares
Formula of NAV

Key Differences Between Market Price and NAV

The main difference is that the market price reflects real-time trading activity, while the NAV provides a snapshot of the ETF’s underlying asset value at the end of the trading day.

While the market price and NAV of an ETF may differ, any deviations are generally minor due to the redemption mechanism used by ETFs. This mechanism ensures that the ETF’s market value and NAV value remain reasonably close. The table below highlights some key differences:

AspectMarket PriceNAV
DefinitionPrice at which ETF shares are traded on exchangesValue of ETF’s assets minus liabilities per share
FluctuationVaries throughout the trading dayCalculated once at the end of each trading day
DeterminantsSupply and demand in the marketValue of underlying assets and liabilities
Trading HoursDuring exchange trading hoursEnd of trading day

Factors Affecting the Difference Between Market Price and NAV

Several factors can cause the market price of an ETF to deviate from its NAV, including:

  • Supply and Demand: High demand with low supply can drive the market price above the NAV, while high supply with low demand can lower it.
  • Market Sentiment: Investor sentiment and market conditions can impact trading activity and influence the market price.
  • Arbitrage Efficiency: The efficiency of the arbitrage mechanism employed by APs can affect how closely the market price tracks the NAV.

What is the Redemption Mechanism in ETFs

The redemption mechanism helps keep the market and NAV values close. This process is done by Authorized Participants (APs hereinafter) which can create or redeem ETF shares in large blocks, known as creation units, typically consisting of 50,000 shares.

Redemption mechanism process in ETFs
Redemption mechanism process in ETFs (Source: Blackrock)

For example: an AP might form a creation unit by purchasing shares in all the companies of the S&P 500 index in the same weighting as the ETF tracking this index. The AP then exchanges this creation unit with the ETF provider for ETF shares of equal NAV value. The AP can sell these ETF shares in the open market. This arbitrage process ensures that any price discrepancies between the market value and the NAV are minimized.

Who are the Authorized Participants and what they do?

Authorized Participants exploit arbitrage opportunities during the trading day to keep ETF market prices in line with their NAV. These authorized participants are large banks such as Morgan Stanley, Goldman Sachs or Bank of America which are tipically market members of the exchange. They do not receive compensation for their role and they do not have a legal obligation to do so. However they are compensated through activity within the secondary markets.

What they do as Authorized Participants? Mainly two things:

  • If the market price of an ETF is higher than its NAV, APs can buy the underlying assets and sell ETF shares, driving the market price down.
  • If the market price is lower than the NAV, APs can buy ETF shares and sell the underlying assets, pushing the market price up.

This arbitrage mechanism helps maintain the balance between the market price and the NAV.

iShares Core S&P 500 ETF (IVV) Market Price vs. NAV

IVV ETF Discount or Premium to NAV
IVV Discount or Premium to NAV (Source: ycharts.com)

Let’s consider the iShares Core S&P 500 ETF (IVV) as of July 5, 2024 for example:

  • Market Price: $557.76 (as of the end of the trading day)
  • NAV: $557.81

This means that the IVV ETF is trading at a discount of $0.05 or, in other words, 0.01% of its NAV. In this case, the minor difference between the market price and NAV can be attributed to intraday fluctuations and the arbitrage activities by APs ensuring the prices remain closely aligned.

On the contrary, as of July 3, 2024:

  • Market Price: $554.33 (as of the end of the trading day)
  • NAV: $554.05

In this case, the IVV ETF is trading at a premium of $0.27 or, in other words, -0.05% of its NAV. Which means that a possible Redemption was needed as the average discrepancy increased slightly.

Related Articles

Related Articles

Distribution ETFs and Dividends
Exchange Traded Funds (ETFs) are financial instruments that blend the features of traded shares and mutual funds. These investment vehicles track an index and can be traded on the stock market throughout the day, similar to individual stocks. One ...

Leave Your Thoughts

Leave a Comment