How do ETFs reflect the growth of an asset

However, what’s less well understood is how the growth of the underlying assets (a la the stocks it’s invested in) ultimately finds its way to the ETFs that you own.

For starters, the share price an ETF trades at is largely determined by the underlying value of the stocks within its portfolio (~ typically referred to as the Net Asset Value or NAV). Secondly, it’s important to know that the NAV or official value per share of an ETF - based on underlying securities’ closing prices - can vary from an ETF’s market price.

How growth is captured via an ETF

Think of the NAV as the value of all the stocks held by the ETF - such as shares or bonds and cash, minus any liabilities, like expenses - and divided by the number of shares outstanding. The NAV of an ETF will go up (or down) depending on the overall performance of the underlying stocks that it owns.

Given that an ETF’s NAV is calculated independently, during and then again at the end of each trading day – based on the most recent closing prices - it will consistently reflect the growth (or losses) of the underlying stocks held within it.

As a result, any plain vanilla ETF that tracks a common index of highly traded securities should always be priced at or very close to the net asset value (NAV).

In very crude terms, here are two primary determinants of an ETF’s price per share.

• If the value of an ETF’s underlying assets goes up, and the number of shares remains (relatively) unchanged, then the price per share will also increase, alternatively:

• If trading demand for an ETF’s shares increases, then more units are created by the provider, and increased supply of shares keeps the share price in line with the ETF’s NAV. By comparison, in the markets for direct shares in listed companies – which is fundamentally different to units of ETFs - demand for more shares than were offered in the market would only drive the price up.

Market maker ensures ETFs trade at NAV

If the difference between bid and offer price, known as the spread, starts to widen, for any number of reasons - including time-lag between markets, liquidity or supply and demand - an ETF will typically choose to use what’s called a ‘market maker’ facility to buy or sell units. It’s the job of the market maker to ensure that bids and/or offers are met, while not straying far from NAV.

While the premiums and discounts to an ETF’s NAV are usually negligible for the vast majority of ETFs, they can be accentuated during bouts of greater market volatility, like we’re currently experiencing.

But there’s no need to panic, by applying a market marker to its portfolio of ETFs, InvestSMART ensures there’s always sufficient liquidity to create and redeem units at the buy/sell price when required. By consistently trading at or very near their NAV –InvestSMART ETFs will always reflect all the growth of its underlying assets.