Sharp swings, steep premiums put International ETFs in focus

Sharp swings and unusually high premiums to NAV have put international ETFs in the spotlight. Here’s what is driving the volatility and why investors need to look beyond recent returns.

WHAT ARE INTERNATIONAL ETFS AND WHY DO INVESTORS BUY THEM?

International ETFs are passive mutual fund schemes that give Indian investors exposure to overseas markets and in dices such as the Nasdaq, S&P 500 and Hang Seng. They are traded on Indian stock exchanges like other ETFs and allow investors to geographically diversify their portfolios without investing directly in overseas markets.

WHY ARE INTERNATIONAL ETFS IN THE NEWS?

International ETFs have been in the news because of sharp volatility, with the market prices of some ETFs trading at steep premiums to their net asset values (NAVs). Some have seen gains or losses of as much as 20% in a single trading session, while the premium to NAV has exceeded 100% in certain cases. For some others, the premium has ranged between 20% and 60%.


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WHY DO INTERNATIONAL ETFS TRADE AT A PREMIUM TO THEIR NAV?

These ETFs are trading at steep premiums because regulatory limits on overseas investments have constrained fund houses from creating fresh units to meet investor demand. Indian mutual funds have an overall industry limit of $7 billion for overseas investments, while investments in overseas ETFs are subject to a separate industry limit of $1 billion. The $1 billion limit was reached in 2024, constraining fresh investments in overseas ETFs.

The NAV of an ETF represents the value of the securities it holds, while its market price is determined by demand and supply on the exchange. Normally, a large gap between the two does not persist because market makers can obtain fresh ETF units and sell them when the market price rises above the NAV, increasing supply and narrowing the premium.

With fund houses unable to create enough fresh units even when demand remains strong, a demand-supply imbalance can push the exchange-traded price of an international ETF well above the value of its underlying portfolio. Sebi’s change in the reference price used to determine ETF price bands has contributed to the recent volatility, allowing premiums over NAV to widen more sharply.

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WHAT SHOULD INVESTORS CHECK BEFORE BUYING INTERNATIONAL ETFS?

Investors should look at the ETF’s exchange-traded price alongside its NAV or indicative NAV (iNAV), rather than focusing only on the performance of the underlying index or the ETF’s recent returns. Buying an ETF at a steep premium can affect returns even if the underlying overseas market performs well. If the premium subsequently narrows, the ETF’s market price can fall even if the value of its underlying investments remains unchanged.