The daily NAV of an ETF represents the value of each share of the ETF. To calculate it, you have to add up the total value of all the assets in the fund (like stocks, bonds, etc.) and subtract any liabilities (debts or other obligations). Now, divide the result so obtained by the number of shares the ETF has issued. This will give you the NAV per share for that day.
It must be noted that sometimes, the price of the ETF in the market does not match the NAV exactly. In such cases, institutional investors usually step in and sell ETF shares if the market price is higher than the NAV. On the other hand, if the market price is lower than the NAV, they buy ETF shares. This process of buying and selling is called “arbitrage”, and it brings the ETF price back in line with the NAV.
Let’s learn in detail how to calculate the fair value of an ETF and understand how institutional investors help keep the ETF price close to their NAV.
What is the net asset value?
To begin with, let’s see what is the net asset value. An NAV is calculated by taking the value of all the assets of the fund (like stocks, bonds, etc.) at their closing prices and dividing by the number of units. For example:
- Say a mutual fund holds stocks worth Rs. 10,00,000 and bonds worth Rs. 2,00,000.
- In this case, the total value of the assets is Rs. 12,00,000.
- Now, if this fund issues 10,000 units, the NAV would be Rs. 120 per unit (Rs. 12,00,000 / 10,000 units).
It is worth mentioning that mutual funds and ETFs (exchange-traded funds) calculate their NAV at the end of each trading day, specifically at the market close time, which in India is 3:30 P.M. IST. This gives you the value of each unit of the fund.
Also, ETFs are traded actively in the market, meaning many buyers and sellers exist throughout the day. This active trading helps in:
- Keeping the market price of the ETF close to the NAV.
- Minimising the differences (variance) between the market value and the NAV.
- Ensuring prices are accurate and reflective of the fund's true value.
However, despite being actively traded, sometimes the market price of ETFs differs from the NAV. Usually, these differences are very small, but if investors want to track performance more precisely, they can use Intraday Net Asset Value (iNAV) instead of just the daily NAV.
An iNAV:
- Updates approximately every 15 seconds during the trading day.
- Reflects the current prices of the underlying assets instead of just the closing prices.
- Provides a more real-time measure of the ETF's value.
Hence, while the NAV provides a daily end-of-day value, the iNAV offers a more real-time value throughout the trading day.
How to Calculate of ETF?
Always remember that at any given moment, the market price of an ETF is determined by the forces of supply and demand. As discussed above, there are some instances when the value of the ETF deviates from its NAV. When such a deviation occurs, institutional investors usually step in to buy or sell ETF shares. This process, known as arbitrage, helps align the ETF's price closely with its NAV.
As a result, the difference between an ETF's market price and its NAV is usually minimal. This allows investors to buy or sell ETFs at prices closely reflecting the value of the assets held within the ETF.
Let’s understand better through a hypothetical example:
- Say you decide to invest in a hypothetical ETF called “A”.
- Suppose the price of ETF A is Rs. 100, and you buy 50 shares for a total cost of Rs. 5,000 (Rs. 100 × 50).
- Three months later, the price increased to Rs. 115.
- Now, your 50 shares are worth Rs. 5,750 (Rs. 115 × 50), thereby giving you a profit of Rs. 750 (Rs. 5,750 - Rs. 5,000).
- Your holding period return is 15% [(Rs. 5,750 - Rs. 5,000) / Rs. 5,000]
It must be noted that while the NAV provides a measure of the ETF's underlying asset value per share, the price you receive when buying or selling ETF shares is determined by the market price and not the NAV.
This is because ETF shares are traded like stocks, and their prices can fluctuate based on:
- Market conditions
- Investor sentiment, and
- Other factors leading to potential deviations from the NAV
However, due to arbitrage mechanisms involving institutional investors, these deviations are generally minimal and the market price tends to closely track the NAV over time.
Having said that, how is the value of an ETF determined?
Follow these steps to compute the daily NAV of an ETF:
- Take the most recent closing prices of the stocks in the ETF (on a weighted basis) plus any cash the ETF holds.
- Deduct any liabilities the ETF may have.
- Divide that amount by the number of ETF shares outstanding.
Mathematically, we can write the following formula:
NAV = (Assets - Liabilities)/(ETF Shares Outstanding) x 100
Note: The actual performance displayed on your brokerage statement for an ETF might differ slightly from the calculation you make from the NAV. This happens because sometimes the market value might be marginally different from the NAV. However, be assured that these differences are mostly small and have minimal impact on your total performance.
Also read: Difference between ETF and index fund
What is an ETF’s NAV?
For the uninitiated, an ETF holds a collection of stocks and sometimes includes some cash holdings. The value of this entire collection, minus any liabilities (like debts or other obligations), is called the net asset value.
To find the NAV on a per-share basis, you need to take this total value and divide it by the number of ETF shares that are currently outstanding (available in the market).
Calculating the value of an ETF
One must note that ETFs are investment vehicles. They hold a basket of securities, such as the stocks in the S&P 500 index. By holding such a basket, they allow investors to gain exposure to multiple assets without needing to buy each one individually. For example:
- Say you decide to invest in an ETF that tracks the Nifty 50 index
- This way, you get exposure to all 50 stocks in the index without the need to hold each stock separately
Also, ETFs trade throughout the day on the stock exchange, just like individual stocks. However, despite being actively traded, sometimes the market price of an ETF differs from the average price of its underlying securities. This deviation makes the ETF appear expensive or cheap compared to its NAV.
Now, to calculate the accurate value of an ETF, you can determine its NAV by taking the end-of-day prices of all the underlying assets in the ETF. Let’s see how:
- Add up the value of all the assets the ETF holds (stocks, bonds, cash).
- Subtract any liabilities (debts, obligations).
- Divide by the number of ETF shares outstanding.
If you want a more precise and up-to-date value during the trading day, you can use the intraday NAV (iNAV), which is updated frequently throughout the day to reflect the current prices of the underlying assets.
Also read: How are ETFs taxed in India
Why do ETF prices remain close to their NAV?
It is essential to note that the ETFs go through a process called "creations and redemptions". This process keeps their market price close to their NAV. Let’s see how it works:
- When the ETF price is above the NAV:
- If the market price of an ETF rises significantly above its NAV, institutional investors enter the market to profit from this difference.
- To do so, they will sell the ETF shares (redeem them) and buy the basket of underlying stocks.
- This creates selling pressure on the ETF and buying pressure on the underlying stocks.
- As a result, the ETF price goes down while simultaneously increasing the NAV to align them closer.
- When the ETF price is below the NAV:
- If the market price of an ETF falls significantly below its NAV, institutional investors will again enter the market to profit.
- This time, they will buy the ETF shares and sell the basket of underlying stocks.
- This buying pressure on the ETF and selling pressure on the underlying stocks will bring the ETF price up and the NAV down.
Investors must note that this process of buying and selling by institutional investors and sophisticated traders is known as ETF arbitrage. It helps to keep the ETF's market price close to its NAV.
Also read: What is SIP in ETFs
Key takeaways
- Exchange-traded funds hold a collection of stocks similar to a mutual fund. They trade throughout the day on stock exchanges, just like individual stocks.
- Despite trading like stocks, ETFs are still valued based on their net asset value, which depends on the prices of the stocks they hold.
- Sometimes, the market price of an ETF can be different from its NAV. However, this difference is usually minimal.
- When an ETF’s price deviates from its NAV, institutional investors enter the market to profit from price differences following a process called arbitrage. This is especially true for more liquid ETFs, where there is a lot of trading activity.
Also read: ETF vs FOF
Conclusion
To calculate the fair value of an ETF, determine its net asset value by adding the total value of its assets and subtracting any liabilities. Divide this result by the number of shares issued.
It must be noted that ETFs are traded like stocks, but despite being actively traded, sometimes their market price differs from the NAV. This difference is generally minimal due to institutional investors performing arbitrage and keeping the ETF’s market price close to its NAV.
Furthermore, while NAV provides a daily end-of-day value, traders can also use Intraday NAV (iNAV), which offers a real-time measure as it is updated every 15 seconds during the trading day.
