Exchange-Traded Funds (ETFs) are pooled investment vehicles listed and traded on stock exchanges like individual equities. They hold a diversified basket of underlying assets such as stocks, bonds, commodities, or derivatives to replicate an index, sector, or strategy. They differ from mutual funds by offering intraday liquidity via continuous trading at market-determined prices. NAV is decided at the end of the day after the market closes, the prices of ETFs, just like stocks, change throughout the day they change based on the demand and supply. They are called the Indicative Net Asset Value (iNAV). But since ETFs are pooled investment vehicles manufactured by asset management companies, they have a NAV too which is declared by the fund house on their website or the various platforms through which they are traded. We understand this can be a bit confusing so let us break it down for you:
NAV vs iNAV
Net Asset Value: This is the official value of the ETF on which the instrument is traded. It is calculated once at the end of each trading day. It is the market price of the ETF, all trades related to the ETF will take place on that price. It is not affected by supply and demand forces.
Formula for normal NAV
NAV= (Total Assets-Total Liabilities)/ Total Number of Outstanding Shares
Indicative Net Asset Value: This is the real-time estimated value of an ETF’s underlying assets during market hours. It tells you the actual underlying or fair value of the ETF. Here is how you calculate the iNAV of any ETF. It is dependent on the supply and demand of the ETF, hence just like stocks, the iNAV changes throughout the day.
Formula for iNAV
iNAV = (Last traded price of all the securities in the ETF basket × number of shares in the ETF creation basket) + cash component) / Total ETF units in the creation basket It helps investors understand the fair value of the ETF at any given moment.
Market Makers
Practically speaking, the NAV (trading price) can be higher (premium) or lower (discount) than the iNAV (fair price) but ideally it should be close. On volatile market days such as budget announcements, elections, etc., there are huge gaps between supply and demand. This is when Market Makers come into play. They create liquidity in the market during low demand situations by buying from the manufacturers (fund houses) and selling to the investors. Conversely, they can also buy from the investors and sell back to the manufacturers when supply is exceedingly high. When buying or selling ETFs, it is important to compare both. Market Makers play between these price differences to make their profit cut.
Market makers control the volatility in the market and prevent prices from going haywire. On high uncertainty days such as elections, budgets, RBI MPC, their capital might get exhausted too, as seen in the past.
In India there are three major market makers: Parwati Capital, East India Securities and Kanjalochana Finserve. All AMCs use their services for the ETF markets. Of these three East India Securities takes the lion’s share at 80% by deploying upwards of ₹500 crore daily while the rest manage 20% of the market.
How can the average investor protect themself
On days like these there can be huge price gaps and ETFs especially can trade at high premiums or discounts. Some underlying stocks in an ETF can also hit their circuit limits, halting their trades. In such situations market makers would hesitate to buy or sell ETF units because of pricing uncertainties. Many ETF investors unaware of the impact high volatility tend to lose money on these days. Although these price differences are temporary, some losses can be permanent, cause distress, and make people lose trust in the markets. It is thus advisable to compare the NAV and iNAV prices side by side before buying or selling an ETF. Avoid greed and panic in such situations and remember that these movements are only temporary.