What is the net asset value in finance

Buy ETF - how to trade index funds through online brokers

Branch bank customers have it convenient. If you want to buy an ETF, simply tell your bank advisor about your order. He then carries out the transaction on the exchange. A few days later, the customer receives an invoice in the mail.

But this service is expensive. Our portfolio comparison shows that investors can save hundreds of euros per year if they switch to an inexpensive direct bank or an online broker. The disadvantage: With these providers, customers have to trade their securities independently. That scares some off.

It's not that difficult to buy ETF on your own. The best way to proceed is explained in our checklist and the one below Video tutorial. In it, we show two live transactions in a real securities account step by step.

Buy ETF - The Fairvalue Checklist

  • Open a deposit with a direct bank or an online broker. We recommend Smartbroker *, ING * and Consorsbank *. You can find details on the conditions of these and other providers in our depot comparison.
  • Select the ETF or ETFs that you want to buy. You can find suggestions in the article ETF Recommendations. Copy the ISIN (International Securities Identification Number) or WKN. This means that you will later find the selected ETF beyond any doubt by searching your online broker.
  • Determine the amount of money you want to invest.
  • Find out about the current price of the ETF, for example on the Frankfurt Stock Exchange website.
  • Divide the amount you want to invest by the current ETF price. This results in the number of ETF shares that you can buy. You must specify the number of so-called pieces in your online order.
  • Log into your portfolio and buy the ETF. The following video shows the best way to do this.
  • If possible, trade ETFs during Xetra's opening hours between 9 a.m. and 5.30 p.m. Xetra is the electronic trading system of Deutsche Börse and the most important reference exchange in Germany. Outside of Xetra trading hours, trading costs on other exchanges can rise noticeably.
  • Check two days after your transactions whether your purchases have been correctly booked into your depot.

Video tutorial: Buying an ETF using the example of ING

For our video we have chosen ING * as an example because it is the largest direct bank in Germany. Other brokers differ in terms of the user interface in detail. However, the procedure shown when buying ETFs can also be transferred to the other securities accounts recommended by us.

The Smartbroker * is currently the cheapest provider on our recommendation list. The Consosrsbank * is an alternative to ING. To the depot comparison

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Buy ETF - What goes on behind the scenes

ETFs are seen as transparent, flexible and inexpensive. But what goes on behind the scenes when trading with index funds is difficult for private investors to understand. In some cases, they pay excessive prices when they buy ETFs. And those who sell during crashes often have to accept particularly high discounts on the fair value of the fund.

Most investors assume that the market price of an ETF share corresponds to the market value of the stocks or bonds in the index fund in the respective mapping ratio. In technical terms, this is called the objectively determinable price Net Asset Value (NAV). The NAV is the fair price for an ETF share.

ETFs often trade below or above their fair value

But on the stock exchange, the prices for ETFs are often well above or below the NAV. The less liquid the securities in the index that the ETF tracks, the larger they are Deviations of the stock exchange price from the net asset value, shows a study by the financial market researcher and portfolio manager Antti Petajisto, which was published in the Financial Analyst Journal.

With very high uncertainty on the stock exchanges and sharply falling prices, such as in 2008 after the bankruptcy of the investment bank Lehman Brothers, the prices for some ETFs can fall by more than 10 percent below their net asset value. This was the case with ETFs on poorly liquid high-yield bonds. Amazingly, these ETFs were comparatively large with billions of dollars in managed capital, traded frequently, and had tight spreads between buying and selling prices.

Even in normal stock market phases, when price fluctuations are at an average level, the stock exchange prices of ETFs, which reflect the performance of less liquid asset classes, can fluctuate by 1 to 2 percent around their net asset value.

The deviations from the NAV were less pronounced for ETFs on broadly diversified stock indices such as the S&P 500 and for ETFs on indices that exclusively contain American government bonds. Both investment segments are very liquid.

Usually there are several competing ETFs on the same index. The stock market prices of these funds do not move in lockstep either. The price of one ETF can be above the NAV, while another ETF on the same index is quoted below its net asset value.

Deviations from the net asset value increase with increasing volatility

For his analysis, Patajisto examined the prices of all ETFs on the US market between 2007 and 2014. In total, the data from 1670 exchange-traded index funds were included in the study. At the end of 2014, these ETFs were managing nearly $ 2 trillion.

The volatility with which the exchange prices of ETFs fluctuate around their net asset value increases when the fluctuation range on the capital markets increases. Patajisto estimates that US investors lose about $ 20 billion a year because they pay too much for their shares when they buy ETFs on the stock exchange. Or get too little for your index funds in the event of a sale.

This money, ultimately hidden costs represents, wanders into the pockets of exchange traders in addition to the spread. According to the study, the “premiums” that the traders collect exceed the income of the ETF providers from the management fees of the funds. Exchange traders dominate ETF trading, continuously setting bid and ask prices and filling in the gaps when no suitable trading partner can be found for an order.

This is how the trading mechanism behind ETF works

Why there are deviations between the exchange price of an ETF and its fundamental value as measured by the NAV is due to this obviously not perfect trading mechanism, which is actually supposed to ensure that both courses largely match.

ETF providers conclude contracts with large trading companies, which are referred to as so-called Authorized Participants (APs) be legitimized. These are the only trading participants to have direct access to the ETF. Only they can return shares in the ETF at the current NAV and receive the corresponding portfolio of securities that the ETF represents. Or they get newly created shares in an ETF and have to deliver securities in return. The shortage or increase in the ETF shares available for trading is intended to ensure that their market price moves close to the net asset value.

How retailers balance supply and demand

The price for an ETF share on the stock exchange, the so-called secondary market, is initially based on supply and demand. Is this For example, supply is higher than demand in a falling market (there are more sellers than buyers), the market price falls below the NAV. It can then be worthwhile for an AP to buy up ETF shares until the market price has risen again to the point where it is quoted close to the NAV due to the higher demand.

At the same time, the AP sells the securities contained in the ETF short for the ETF shares acquired to secure against price changes and at the same time to collect the difference between the ETF market price and the NAV as a profit. In turn, in the securities market, selling leads to more supply, which tends to lower the net asset value of the ETF.

ETF trading: professionals earn money with price differences

Fictitious example: Assume an ETF share on the Stoxx Europe 600 share index costs 98 euros on the stock exchange. However, the stocks in the weighting of the index and the mapping ratio of the ETF have a combined market value of 100 euros. The ETF is quoted 2 euros below its NAV.

Now an Authorized Participant buys ETF shares for 98 euros and sells the Stoxx Europe 600 empty for 100 euros in the same amount. For example, he borrows the shares from a fund for a premium of one euro (per ETF share).

The AP makes a profit of one euro (100 - 98 - 1 = 1) per ETF share, but now sits on the ETF and owes a fund the Stoxx Europe 600 shares. At the end of the trading day, the AP returns the ETF shares to the provider. In return, he receives Stoxx Europe 600 shares, which he in turn returns to the fund from which he borrowed them. All trading positions are now closed.

The AP has exploited the price difference between the exchange price of the ETF and its NAV and made a profit in this way. This is what traders call "arbitrage". At the same time, the transactions ensured that the ETF's market price approaches its NAV again.

This trading mechanism works the other way around when an ETF is quoted on the exchange above its NAV. The Authorized Participants then shorts the ETF shares and simultaneously buys the securities that the ETF contains.

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Exchange traders need to hedge against price fluctuations

The AP wouldn't each hedge with an opposite trading positionif he himself would be exposed to the price risk of the ETF shares. Assuming in the example given above, the AP only buys the ETF shares for two euros below their NAV at the beginning of a trading day and does not sell the Stoxx Europe 600 shares short. Then at the end of the day he would also receive the shares in the mapping ratio of the ETF share from the provider. But if the shares are only worth 95 euros at this point, the AP makes a loss of three euros.

Therefore, if the trader wants to take advantage of the differences between the exchange price of the ETF and its net asset value, each time he buys or sells an ETF unit, he opens an opposing trading position, with which he hedges the risk of price fluctuations over the course of the day. "Hedging" is what it means in the financial sector.

Buying an ETF: The Limits of Arbitrage

If the security price falls sharply, the hedging costs for authorized participants increase. For example, it is more expensive to borrow securities to sell short because the demand increases. The prices for put options are also climbing. The higher protection costs are reflected on the stock exchange in higher differences between the selling and buying prices of ETF units.

At the same time, however, arbitrage business is also becoming less attractive. The result: The exchange price of an ETF is more strongly influenced by the supply and demand for ETF shares. If there are more sellers than buyers, the exchange prices for ETFs slide below their net asset value.

Arbitrageurs generally set the limits on the cost of hedging. If they are higher than the price differences between the exchange price of the ETF and its NAV, arbitrage transactions are not worthwhile.

What risks professional traders bear

A risk for Authorized Participants is that the cost of hedging cannot always be predicted with certainty, especially for less liquid investments such as corporate bonds. In addition, APs are a Timing risk exposed. Because it is not always possible to trade the securities portfolio that the ETF represents at the same time as the ETF shares. If this does not succeed, an AP is exposed to price risks (see above).

Since the minimum size for a transaction between the ETF and an AP is on average 100,000 shares, according to experts it can take several days for some asset classes to build up a correspondingly large securities position.

As a result, the arbitrage mechanism of APs is the least used in ETFs on asset classes that are the most difficult and expensive to trade. If, however, arbitrage transactions are only rarely made, the ETF's stock exchange price fluctuates more around its net asset value, says financial market researcher Antti Petajisto in his study.

When the arbitrage mechanism fails

Due to the increasing popularity of ETFs and their growing influence on the international financial markets, they are now also settling Regulatory authorities with possible worst-case scenarios apart. The Irish central bank, for example, is investigating in a discussion paper what would happen if all Authorized Participants were to withdraw from the so-called Primary market trading with an ETF withdraw. This would be conceivable in extreme market situations in which arbitrage transactions would be too risky, for example because the securities that ETFs track are no longer traded and there are no market prices for Disorientation would worry.

One A foretaste of such extreme situations the American stock market delivered on August 24, 2015. The night before, the stock exchanges in Asia and Europe had fallen relatively sharply by 3 to 5 percent. In early morning US pre-market trading, a future on the S&P 500 index was already 5 percent in the red.

When the stock exchange opened in New York at 9:30, there was no stopping it: the prices of many stocks fell by around 20 percent. Ten minutes later, on the stock exchange for half an eternity, almost half of all stocks had not yet started trading.

The prices of many stocks that could be bought and sold fluctuated so wildly that trading in them had to be suspended a total of 1278 times due to stock exchange regulations.

ETFs on US stocks fell well below their real value

The Panic caused the arbitrage mechanism to collapse of ETFs that track US stock indices. Their stock market prices fell well below their net asset value. While the US market fell by around 5 percent overall, 19 percent of all ETFs collapsed by 20 percent or more. After half an hour the ghost was over. The market normalized again.

The world's largest ETF provider, Blackrock, then made it clear in an analysis of the events: Authorized participants need almost 100 percent price transparency on the respective market in order to identify arbitrage opportunities and secure themselves. Is there no reliable or no market prices at all for a large number of US stocks as on that fatal trading day, Authorized Participants are withdrawing. The exchange prices of ETFs can then drift far away from their NAVs because no more ETF shares are withdrawn from the market or reissued in order to regulate excess supply and demand. In such a stressful situation, investors can only monetize their ETF units if they enormous discounts accept.

Authorized participants are not required to participate in ETF trading

An AP is independent of the ETF provider. He does not receive any remuneration for his trading activities. To that extent there is also no obligationto participate in ETF trading. If all APs withdraw from an ETF, the link between the primary and secondary market is missing - exchange prices and net asset values ​​are drifting apart. The ETF provider itself is also not obliged to provide prices that are close to the net asset value.

Even if the APs withdraw, so-called still trade on the exchange Official Liquidity Provider (OLP). They ensure that investors can buy and sell ETFs at any time. OLP are exchange traders, known as Market maker Set buying and selling prices for ETFs on an ongoing basis. You buy or sell if no counterparty can be found in the trade for an order.

The OLP, which is based on Xetra, the electronic trading system of Deutsche Börse, "Designated Sponsor" are called and on the Frankfurt floor exchange "Specialists" have contracts with the respective stock exchanges which oblige them to participate in trading to a certain extent. In addition, they can agree with ETF providers to ensure additional liquidity. They receive remuneration for these services.

If market makers buy ETF shares from investors or sell them short, they must protect themselves just like the Authorized Participants in order not to expose themselves to the risk of price losses. Because they are just as little speculators as APs, but traders who primarily benefit from the difference between buying and selling rates, the Spread, to earn.

Inspectorates discuss additional trade rules

If your risks and hedging costs increase, this is also reflected in larger spreads. Their maximum amount is limited by the Frankfurt Stock Exchange. But in stressful situations it can do a so-called Fast market calling out. The spreads may then exceed the actual maximum. What this means for investors is that not only may they have to accept a discount on the net asset value, but they may also pay higher transaction costs.

Because exchange-traded index funds do not keep the promise that they can continuously be bought and sold at fair market prices, the supervisory authorities are currently discussing whether the providers can accommodate their investors in prolonged stress phases by offering shares at the end of each trading day redeem directly from investors at net asset value.

This is the usual procedure for traditional investment funds. In contrast, investors have to buy ETFs on the stock exchange. Only Authorized Participants have direct access to these funds. And the providers don't want to change anything in an emergency. According to a survey by the Irish central bank, a clear majority of ETF providers against the direct redemption of units pronounced by investors.

Buy and sell ETFs - recommendations for investors

Even if investors are well informed and know about possible differences between the market price and the net asset value, this knowledge is often of little use to private investors. Unlike market makers, they are not able to continuously calculate the NAV of ETFs in real time.

It is true that ETF providers are generally obliged to continuously calculate a so-called indicative NAV, or iNAV for short, for each ETF. However, this data is often not accessible to everyone. On the Frankfurt Stock Exchange, for example, it is enough if the iNAV is in real time Data provider for professional investors like Bloomberg is published.

The respective iNAV is usually only available on the website of the trading venue if the ETF provider has commissioned the Frankfurt Stock Exchange to calculate it. That is why even well-informed private investors cannot usually recognize differences between the market price and NAV and include them in their purchase or sale decision.

Come in addition: The iNav is not always meaningfulbecause in some cases it is based on outdated data. This is the case, for example, with international indices that contain stocks from countries whose stock exchanges are closed, while ETFs on these indices are traded in this country. For example, ETFs on the MSCI World share index, German investors should only buy and sell from 3:30 p.m. onwards. This is the time of day when trading in US stocks begins, which dominate the index with a share of more than 60 percent.

In the case of ETFs on liquid, European securities such as stocks and government bonds, investors can assume that stock exchange prices will be close to the net asset value as long as trading remains normal. With increasing volatility and generally with ETFs on less liquid securities such as corporate bonds, great caution is advised. Private investors should only buy and sell such ETFs if they can be sure that they will not have to pay a major discount or premium.

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