Morningstar - Q2 2020 - 51

bankruptcy in September 200 through early 200 .
During this span, the average daily premium
was 2.3%.
On Aug. 2 , 2015, many ETF rie raded a
substantial discounts to their true value. An
ear m rnin e
ri ed ir ui rea er a
temporarily suspended trading in a number
of stocks and, as a result, many ETFs that held
those same stocks. Some investors fell victim to
this downdraft, having placed trailing stoploss orders in these funds' shares that became
market orders at precisely the wrong time. Others
were able to capitalize on this situation, placing
buy orders for baskets of blue-chip stocks
at bargain-basement prices. Episodes like these
underscore the importance of assessing
market conditions before trading ETF shares and
practicing safe trading.
Trading Safely
There is nothing investors can do to directly
manage the inevitable premiums and discounts
to NAV in the ETF market. Fortunately, these
discrepancies tend to be fairly small and
ee in
an
e r
ee in e a i r
er e
m e i i e mar e ma er
i
should not be a major concern for most longterm investors.

However, when trading ETF shares, it is worth
checking whether your buying or selling price is
close to its iNAV. Not all brokerages make
i in rma i n a ai a e. u an nd ETFs' iNAVs
on their quote pages on Morningstar.com and
in Morningstar Direct.
While iNAV is a useful touchstone, the prevailing
market price is often the best indicator of a
fund's going value. At any given time, market
makers and other investors place their bid and ask
prices on either side of their estimate of an
ETF's fair value. If the bid and ask quotes are only
a penny or two apart, the midpoint of the two
numbers is probably an even better approximation
of the NAV at that time. This is because
supercompetitive market makers are leveraging
their own proprietary pricing models to assess
ETFs' fair values at hyperspeed during the trading
da in an e r main ain eir ed e er
competitors. Also, iNAV isn't as useful for bond

TRENDS

Back to Normal?
Market volatility in early March caused the
prices of some exchange-traded funds to come
unmoored from their NAVs-particularly
r ed in me ETFs. But episodic dislocations
are a feature of ETFs, not a bug. These
circumstances create opportunities for ETF

Intermediate Core Bond
Ultrashort Bond

Corporate Bond
Short-Term Bond

mar e ma er
r
r m rin in ETFs' prices
back in line with their NAVs. During the
week of March 23, the prices and NAVs for many
of the ETFs that saw the most extreme discounts
were again reunited. As of March 25, things
were mostly back to normal.

Intermediate Government

Median Premium/
Discount
2.5%

0

-2.5

-5.0
02/25/2020

03/10/2020

03/25/2020

Source: Morningstar Direct.

funds or portfolios containing international
securities, as their prices are likely stale. The SEC
recently acknowledged this in its new ETF rule
and no longer requires issuers to hire a third party
to calculate and disseminate the value on
their behalf.
Ultimately, the best way to protect oneself from
these dislocations is to avoid trading during
these episodes when ETF prices disconnect from
their NAV.
But if you must trade, practice safe trading. In all
cases, using limit orders is good practice. Limit
orders will ensure favorable execution from a price
perspective. A buy limit order will fetch the buyer a
price less than or equal to the limit price, while a
sell limit order will transact at a price greater than

or equal to the limit price. What is the potential
cost of using limit orders? Time and incomplete
execution. That is, it may take longer for a limit order
e ed an a mar e rder and en a
ime me i mi n e m e e
ed. e e
costs need to be weighed against the cost of
being exploited by an opportunistic market maker
in
i
mar e rder .
And for those investors who can't or don't care
to get comfortable with all the above, there
is an expansive menu of index mutual funds to
choose from that will guarantee your orders
are executed at NAV. K
Ben Johnson, CFA, is director of global exchange-traded
fund research for Morningstar. He is a member of the
editorial board of Morningstar magazine.

morningstar.com/lp/magazine

51
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