During these turbulent times, how does one track and value the performance of an exchange-traded fund? David Mann, Head of Capital Markets, Global Exchange-Traded Funds, opines on ways to “keep score.
Most of the exchange-traded fund (ETF)-related content I have read over the past week has focused on the behavior of fixed income ETFs during this unprecedented time of market uncertainty. I would put that content into two main groups:
- Stale net asset values (NAVs)1:questions as to the true value of the underlying bonds given all the market uncertainty.
- ETFs serving as the price discovery vehicle: the ETF is the “actionable” price, allowing buyers and sellers to transact on exchange for a specific fixed income exposure.
Keep those two points in mind for this discussion on ETF performance (and for now, let’s put to the side the Federal Reserve’s recent announcement it will be buying fixed income ETFs). Usually performance is measured over very specific timeframes such as year-to-date or looking back 1/3/5 years. Exceptions to that happen during extreme market events like we are currently experiencing as investors want to judge how the active management or smart beta methodology compares to the overall market.
For ETFs, there are two main ways to keep score: ETF NAV performance and ETF market price performance. The first is generally the preferred method as it allows for more “apples to apples” comparisons among funds given some ETFs have wider bid/ask spreads and/or trade less frequently, which could cause extra variation with the ETF’s market price.
Valuing Fixed Income
For the first point listed above, keeping score via NAV is going to be problematic right now given current market turbulence and uncertainty. Valuation methodologies put in place have most likely never dealt with the extent of illiquidity currently roiling the fixed income space.
And if there is doubt as to the value of the underlying bonds, then that puts the performance calculations in doubt as well.
So, then maybe we switch to the ETF price in order to measure performance? There are two problems with this method. The first I have talked about in my last post—ETF spreads have widened across the board, and there could be a significant ETF performance difference depending on if the ETF closes near the bid or near the offer.