In a previous article, we explained some of the differences in the way exchange-traded funds (ETFs) are traded in Europe versus the more mature US market.
Here, we’re going to explore the two approaches in a bit more detail and delve into the different situations in which each method might be attractive.
First, let’s remind ourselves of the two ways to trade ETFs in Europe:
- At net asset value (NAV)1—based on the closing prices of the underlying constituents of the ETF.
- “On screen/At risk”—based on the real-time prices quoted throughout the day. Investors trading via this approach can buy an ETF at any time during trading hours.
The choice of which approach to follow will depend on investor preference.
There are some specific instances in which buying (or selling) an ETF at NAV might appear attractive to investors, in particular when switching—either out of a mutual fund into an ETF or between similar ETFs.
An investor switching out of a mutual fund into an ETF will want to ensure the smoothest possible transition. As he or she will have to wait until end of trading to exit the mutual fund, it may prove more efficient and attractive to acquire the ETF exposure in the same fashion.
Similarly when switching between ETFs, conducting a NAV trade may prove an attractive and efficient consideration to ensure seamless exposure to the desired assets, as long as the methodologies used to calculate the value are broadly similar or if the two funds share a significant amount of common holdings.
However, trading at NAV may prove less attractive in other circumstances.
Imagine, for example, an investor looking to trade a global ETF—one based on a basket of global underlying constituents such as equities listed on stock markets around the world.
In a 24-hour cycle, the NAV of that ETF will only be marked when all of the markets in which the underlying assets are traded have closed.
An investor in London, for example, would have to wait until US markets closed the following day to mark the NAV.
So, an investor looking to get immediate exposure to a global product may appreciate the flexibility and clarity of trading “at risk”, which offers intraday pricing.
Of course, when trading a global ETF “at risk” there may be some assets listed on stock markets that are outside of trading hours when the investor wants to make the trade. In those instances, the market-makers2 will give a price based on underlying proxies for that market, effectively a price that is highly correlated with the underlying market. For example, the S&P 500 futures market, which trades virtually around the clock, may be used as a proxy for pricing an ETF based on the underlying S&P 500 Index, when the US market is closed.
“At Risk” Order Types
When trading “at risk”, an investor can employ one of two order types, similar to trading single stocks: market orders or limit orders.
A market order is executed at the price on the screen. The attraction for an investor is that the entire order is done. On the other hand, the investor has no control over the price at which the trade is executed as prices can quickly move.
A limit order initiates when the price gets to a specified level or better. The benefit of a limit order is that it allows an investor to define a maximum or minimum price at which they want to buy or sell the ETF. However, if the price is far from the specified level and doesn’t hit it in the time the order is open, the order may not actually get filled. For example, a buy limit order might specify an individual will not pay more than €20 per share, so the order will not be filled if the market is trading at €21 and continues to move up.
So far I’ve discussed the two methods for trading ETFs in Europe and the different trading approaches. Next time, I will be discussing some of the myths surrounding liquidity and ETFs.
Jason Xavier’s comments, opinions and analyses expressed herein are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.
What Are the Risks?
All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Brokerage commissions and ETF expenses will reduce returns. ETF shares may be bought or sold throughout the day at their market price on the exchange on which they are listed. ETFs trade like stocks, fluctuate in market value and may trade above or below the ETF’s net asset value. However, there can be no guarantee that an active trading market for ETF shares will be developed or maintained or that their listing will continue or remain unchanged. While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.
Data from third-party sources may have been used in the preparation of this material and Franklin Templeton Investments (“FTI”) has not independently verified, validated or audited such data. FTI accepts no liability whatsoever for any loss arising from use of this information, and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FTI affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction.
1. Net Asset Value (NAV) represents an ETF’s per-share-value. The NAV per share is determined by dividing the total NAV of the fund by the number of shares outstanding.
2. A market maker is a firm or individual who facilitates liquidity by standing ready to buy or sell a particular security throughout a trading session.