International ETF premiums: Why some ETFs trade far above their underlying asset value
Cutting through money jargon, one topic at a time. This week Abhinav Kaul explains why some international exchange-traded funds (ETFs) trade at prices far above what their underlying assets are worth.
When you buy an international exchange-traded fund (ETF) on the Indian stock exchange, say, one that tracks US or Taiwanese stocks, you’d expect to pay a price close to the actual value of the stocks held inside. But that is often not the case.
Many international ETFs trade at prices signicantly higher than the value of their underlying assets. This gap is called a premium and, in some cases, it can be over 10%, 20%, and even higher.
What premium means
Every ETF has a net asset value (NAV)— the value of all the stocks or assets it holds, divided by the number of units. The market price is what someone is willing to pay for that unit on the exchange. When the market price is higher than the NAV, the ETF is said to be trading at a premium, i.e. you are paying more than the ETF is actually worth.
iNAV versus NAV
The root cause
The reason this happens with interna tional ETFs speci cally comes down to a regulatory limit. Indian regulators cap the total amount Indian mutual funds can collectively invest overseas. This overall industry limit has been exhausted for some time. As a result, fund houses that run these ETFs cannot buy fresh inter national stocks, even when new inves tors pour money in. The supply of ETF units gets frozen. Demand keeps coming in, but no new units can be created to absorb it. Prices on the exchange then get pushed up by buyers competing for a limited pool of units.
Why price won’t correct
In a normal ETF, if the market price rises above NAV, large institutional investors called authorised participants step in. They create new units at NAV and sell them on the exchange, bringing the price back down. This mechanism is called arbitrage. But when the overseas limit is exhausted, this route is blocked. No new units can be created. So the arbi trage mechanism, the safety valve that normally keeps ETF prices honest, simply does not work.
iNAV vs NAV
The NAV is calculated at end of day, using previous night’s closing prices of foreign stocks. The indicative NAV is a real-time estimate, updated through the trading day, and is a better re ection of what the underlying assets are worth at that moment. When checking whether an ETF is trading at a premium, compare the market price against the iNAV, not the previous day’s NAV, which can be stale and misleading.
When it collapses
Premiums do not last forever. When the overseas limit is raised, or sentiment shifts, the premium can compress quickly and sharply. An investor who bought at a 20% premium and sells when the premium has fallen to 2% loses that 15%, even if the underlying index stayed at or rose. This is the hidden risk.
Before you buy
Before investing in any international ETF, check four things. First, is the fund currently accepting fresh subscriptions, or has it stopped due to the overseas limit? Second, how wide is the current premium, compare the exchange price to the latest iNAV. Third, has this premium been historically stable or does it swing widely? Fourth, consider if a fund of funds investing in the same underlying market is available, these may offer a more fairly priced route, though they come with a different cost structure.
