However, ETFs that track less liquid markets-such as high-yield bonds, commodities, or emerging markets-can display differences of 1% or more, usually due to lack of liquidity but sometimes because of more complex factors.

A good example of this is an ETF that tracks the S&P 500 ® and whose market price might not stray more than 0.20% or so away from its NAV. stocks-typically display only small premiums or discounts. When the securities that make up the index an ETF tracks are easily priced because many buy and sell orders are being placed in a centralized exchange, 'creating' a basket of securities to replicate the index is relatively straightforward.Īs a result, ETFs that track heavily traded, highly liquid markets-like U.S. In the case of an ETF that trades at a premium, for example, authorized participants selling newly created ETF shares increase the supply in the market, which helps drive down the price of the ETF closer to its NAV. As they conduct arbitrage trades, they help bring the ETF's market price into better alignment with its NAV. This process of exchanging baskets of the securities in an index for shares of the ETF is called the in-kind creation/redemption mechanism, and it's the reason ETF premiums and discounts are generally self-correcting.ĭeviations from NAV create profit opportunities for authorized participants. An authorized participant might attempt to capture that premium by simultaneously purchasing a basket of the underlying securities the ETF tracks, exchanging the basket of securities for shares of the ETF, and selling the shares in the open market. To illustrate this point, let's assume that an ETF is trading at a premium of 1% to NAV. When material differences do manifest in ETF prices, large institutional investors (called authorized participants) usually help the market self-correct by attempting to profit from arbitrage trades that serve to better align an ETF's market price and NAV. In general, most ETFs exhibit small discounts and premiums. Conversely, if the stocks the ETF holds are worth $30.25 per fund share, the ETF is trading at a discount of 0.83%. If the individual stocks the ETF holds are worth only $29.90 per fund share, then the ETF is trading at a premium of 0.33%. An ETF is said to be trading at a discount when its market price is lower than its NAV-that is, you're buying the ETF for less than the value of its holdings.įor example, imagine an ETF that trades in the market at $30 per share.

This potential cost differs from the others because it can be a positive factor on overall returns-for example, it might increase your return instead of decreasing it.Īn ETF is said to be trading at a premium when its market price is higher than its NAV-simply stated, you're paying a bit more for the ETF than its holdings are actually worth. The last (and possibly least understood) potential cost comes from changes in discounts and premiums to NAV during the period you hold an ETF.

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