Portfolio construction

Pricing ETFs: How premium/discount is calculated

April 01, 2024 - 3 min read

Senior Vice President, Head of Institutional Product and ETFs – Natixis Investment Managers – US Distribution

Some financial advisors and investors may have questions about how premium/discount¹ functions for an exchange-traded fund (ETF)². However, investors interested in buying or selling ETFs should carefully consider a range of information, not just premium/discount. Secondly, when considering premium/discount, it’s best to understand what the figure actually represents. Let’s start by defining what is being compared in the premium/discount figure and how it is being calculated, then look at how the value can be interpreted by investors

Defining the premium/discount calculation

Simply put, the premium/discount compares the market price of an ETF³ (often represented by a mid-point price) to the ETF’s net asset value (NAV).⁴ The mid-point price is the mid-point between the bid, or the price at which an investor could sell an ETF, and the ask, the price for which an investor could buy an ETF. The NAV is a close-of-day value for all the securities in the ETF. Unlike a mutual fund that has just one price (the latest NAV), an ETF has these two pricing sources – market price and the latest NAV.

The premium/discount calculation is a daily snapshot, specifically at the time the NAV is being struck (typically at the market close). In order to calculate the premium/discount, one takes the difference between the market price and NAV as a percentage of the NAV. A positive number means the ETF market price is trading above the NAV, or at a premium. A negative number means the ETF market price is trading below the NAV, or at a discount. Easy enough? Not so fast.

More calculating: iNAV

To further complicate things, many ETFs publish an intraday NAV (iNAV) during US trading hours so investors have a sense of what the underlying portfolio is worth at a point in time. The iNAV is typically disseminated every 15 seconds throughout the trading day based on the most recent prices. The ETF market price and the iNAV can fluctuate throughout the day, but the actual premium/discount refers to the end-of-day difference.

Reading the numbers, accounting for time

iNAV is a useful tool, but there are special considerations that must be taken into account when interpreting it for US-listed ETFs that hold underlying securities that trade in markets whose hours differ from those in the US (e.g. international equity funds).

For domestic ETFs, premium/discount will often remain near zero because the ETF and the portfolio of securities are traded during the same market hours and the values are widely known. By contrast, an ETF with international underlying securities may show greater premium/discount at times because of the nature of the inputs used to calculate each value. To show what I mean, let’s look at an example of an international ETF traded during US hours.

When the US markets open and the ETF begins trading, a majority of the international underlying securities have already closed. Once the last international local market closes for the day, the input prices used to calculate the iNAV are fixed and the iNAV will only change based on currency moves for the remainder of the day. However, market makers will apply a fair value methodology⁵ to help determine the ETF market price, and will continue to make real-time markets until the end of the US trading day. Market makers have other tools at their disposal to manage these timing-related pricing challenges, including futures,⁶ American Depositary Receipts (ADRs),⁷ and proxy portfolios⁸ that also trade around US hours. Any news that will impact trading during US hours will be accounted for in real time in the market price of the ETF. Remember, in this case, the iNAV represents the most recent closing prices while the ETF market price represents the expectations of the next open in the local international markets at that point in time. Again, the apparent difference emerges because the iNAV is using “stale” closing prices while the ETF market price is set by real-time inputs and real trades during the US trading day.

Knowing the numeral

In the end, what is important for investors to take away is that premium/discount can be a useful metric when evaluating an ETF, but it’s not as useful for an ETF with securities that close at different times. What’s more, financial advisors and their clients may want to consider a range of factors when evaluating ETFs. These could include the total cost of ownership, portfolio construction methodology and the expertise of the investment management team. Investors interested in buying or selling international ETFs should carefully consider a range of information, not just premium/discount.

¹Here, the terms “premium” and “discount” refer to whether an exchange-traded fund (ETF) is trading at more or less than its net asset value (NAV) or intraday net asset value (iNAV). ETFs trading at a price that is higher (or more than) NAV or iNAV are said to be trading at a premium, whereas ETFs trading at a price lower (or less than) NAV or iNAV are said to be trading at a discount.

² An exchange-traded fund, or ETF, is a marketable security. ETFs trade like a common stock on a stock exchange and experience price changes throughout the day as they are bought and sold.

³ An exchange-traded fund’s (ETF’s) market price is the price at which shares in the fund can be bought or sold on the exchanges during trading hours.

⁴ An exchange-traded fund’s (ETF’s) net asset value, or NAV, represents the value of each share’s portion of the fund’s underlying assets and cash at the end of each trading day.

⁵ Fair value refers to an asset's sale price agreed upon by a willing buyer and seller, assuming both parties are knowledgeable and enter the transaction freely.

⁶ Futures are financial contracts obligating the buyer to purchase an asset, or the seller to sell an asset, at a predetermined future date and price.

⁷ An American Depositary Receipt, or ADR, is a negotiable certificate issued by a US bank representing a specified number of shares in a foreign stock that is traded on a US exchange.

⁸ A proxy portfolio is a broad representation of the overall market, used to simplify studies that require a market variable, statistic, or comparison.

Exchange-traded funds (ETFs) trade like stocks, are subject to investment risk, and will fluctuate in market value. Unlike mutual funds, ETF shares are not individually redeemable directly with the Fund, and are bought and sold on the secondary market at market price, which may be higher or lower than the ETF's net asset value (NAV). Transactions in shares of ETFs will result in brokerage commissions, which will reduce returns.

This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.

All investing involves risk, including the risk of loss. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.

ALPS Distributors, Inc. (Member FINRA) is the distributor for Natixis ETFs. ALPS Distributors, Inc. is not affiliated with Natixis Investment Managers. Natixis Distribution, LLC (Member FINRA | SIPC) is a marketing agent.

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