How to Calculate the Value of an ETF

 

While ETFs (short for Exchange-Traded Funds) are great gateways to get broad exposure to bonds, stocks and commodities without taking any specific risks,  they can, unfortunately, be tricky to evaluate from an investor’s perspective since they have pricing characteristics of both mutual funds as well as stocks. 

So worry not, we are here to help you get a rough idea before you start investing!

Because ETFs, like mutual funds, hold a market basket of multiple companies' shares, their value is measured as a Net Asset Value (NAV), which represents the total value of the ETF's underlying holdings.

The formula is fairly straightforward. To maintain things on a per-share basis, NAV is the sum of all the assets in the fund minus the fund's liabilities, which is then divided by the number of outstanding shares. 

Calculations based on the price mixes of the securities are commonly used to assess the NAV.

NAVs are calculated using "Creation Units" rather than outstanding shares to arrive at a relevant per share basis. CUs (Creation Units) are enormous blocks of shares (tens of thousands) that make up the ETF's "denomination." 

It establishes the connection between ETF shares and the underlying securities mix. You may consider them to be a type of unit conversion factor.

Because the funds comprise both cash and securities, they must be taken into consideration. This increases the number of terms in the NAV computation. The cash figure is subtracted from the liabilities figure.

The NAV calculation looks somewhat like this with the said adjustments:

((summary of shares per each component stock) (price for that stock))/CU shares + (total cash)/CU shares = NAV.

Because ETFs are created and redeemed, institutional investors and expert traders will sell (redeem) ETFs and purchase the underlying stock basket when the ETF price climbs too far above the NAV, and vice versa when the market price falls far below the NAV. 

This ETF arbitrage mechanism tends to keep the price close to the NAV. Luckily, don't have to compute the NAV yourself. It is available on numerous websites and is issued at the end of each trading day for ETFs, exactly like mutual funds.

Switching gears, let us now look at the differences between Exchange Traded Funds and stocks. 

ETFs, like stocks, are frequently traded on exchanges, therefore the "actual" NAV at any given time has a tendency of fluctuating during the day (unlike mutual funds).

A daily NAV update may be sufficient for you if you are an ETF buy-and-hold investor. If you're a more active trader, though, trading off of a NAV valuation means you're trading on "ancient" data, and you can overpay for an ETF based on it. 

Because you know the current price but not the current value of the underlying stocks, you can't tell if the ETF is temporarily overpriced.

The Indicative Net Asset Value (iNAV), also known as the Intraday Indicative Value, is a financial indicator (IV). This value is updated every 15 seconds to reflect the underlying securities' value as near to real-time as feasible.

The iNAV uses the identical formula, with the exception that the price is based on the current price rather than the closing price, and the total cash is projected because the cash value is reported daily. 

You don't have to calculate the iNAV again, which is great news for you. It is traded on the stock exchange under the symbol ETF.IV or a close variant.

You may obtain a sense of whether an ETF is overpriced by comparing the NAV/iNAV with the current market price and bid/ask spreads — providing your data is up to date.

One thing to be kept in mind is that foreign currency markets will be open when local markets are closed. 

Events that might influence the price of the ETFs overnight have not yet been included in the securities' prices, resulting in price and NAV discrepancies. You must investigate if the disparity is justified by the occurrences.

Although you are unlikely to need to compute a NAV or an iNAV by yourself, understanding where to look for them and how to apply them can assist you in making prudent ETF purchases. Just be grateful that someone else is crunching the numbers for you!

Written by – Devika Mishra