Buried deep in the prospectus for the three newly launched Vanguard ETF Portfolios is the standard industry disclaimer: units of exchange-traded funds may trade at premiums or discounts to their net asset value (NAV).
That was emphatically true on Feb. 5, a day when equity markets plunged around the world. Despite the market carnage, each of the five-day-old Vanguard ETF Portfolios ended the day at prices higher than their previous daily close on the Toronto Stock Exchange.
What's wrong with this picture is that the market closing prices were at steep premiums to the net asset values of the underlying ETFs that the portfolios hold. These wide discrepancies illustrate one of the lesser known and less publicized risks associated with the ETF structure over the very short term. They also raise questions as to what, if anything, ETF providers can or are willing to do to mitigate trading risks.
As posted today on Vanguard's website, Vanguard Growth ETF Portfolio -- whose mandate is to be 80% invested in broad market-cap-weighted equity-index ETFs -- closed at $25.30 on Feb. 5, up 88 cents or 3.6%. Yet the closing NAV of this portfolio was only $24. What this means is that the market close was at a steep 5.4% premium to the NAV.
The premium to NAV was much narrower on the same day for Vanguard Balanced ETF Portfolio, whose equity allocation is 60%. It closed at $24.85, up 34 cents or 1.37% on the day. That translated into a market closing price that was at a 2.6% premium to net asset value.
The most startling discrepancy between the market close and net asset value was for Vanguard Conservative ETF Portfolio, whose equity allocation is only 40%. Its market close was $27.37, up $2.75 on the day or 11.2%. Meanwhile, the closing NAV was $24.46. That translates into a Feb. 5 market close that was at a whopping 11.9% premium to the NAV.
Asked by Morningstar to comment, a Vanguard spokesperson said via email that the wider than normal spreads between the market prices and the NAV of the asset-allocation ETFs at yesterday's close, "similar to most other ETFs in the market, was a short-term event due to the large spike in market volatility late yesterday afternoon." As of today's market opening, "the issue has corrected itself and ETF spreads have returned to their normal range."
In volatile markets, the Vanguard statement continued, it is more difficult for market-makers to price ETFs with certainty. "This can result in wider bid-ask spreads for a short period. We advise investors to avoid trading at market open or close since sometimes the bid-ask price is a little unsettled and wider at these times."
The premium trading prices occurred on the same day that a smiling and clapping group of Vanguard staff, led by Vanguard Canada head Atul Tiwari, were on hand at the Toronto Stock Exchange for a ceremonial market opening. It was billed as a celebration of the launch of the ETF Portfolios, which had begun trading on the TSX on Feb. 1.
In a press release issued on the launch date, Vanguard touted the ETF portfolios as "simple yet sophisticated single-ticket investment solutions" and noted their low management fees of 0.22%.
The reality is that getting a fair and reasonable price when investing in these portfolios, or ETFs in general for that matter, isn't so simple. Market prices will vary during the course of the trading day, and not only because of fluctuations in the net asset values.
The price that you pay to acquire ETF units will also depend on the bid-ask spread, which tends to be wider for newly launched products like the Vanguard portfolios.
Not coincidentally, Vanguard Conservative ETF Portfolio, which had the priciest market close relative to NAV, also had the lowest trading activity of the three portfolios. Trading volume on the TSX on Feb. 5 was a mere $316,000, with only 25 trades. Meanwhile, Vanguard Balanced had trading volume of $1.28 million in 114 trades, and Vanguard Growth had $1.91 million in volume and 267 trades.
By comparison, large TSX-listed ETFs have thousands of trades during the course of a day, which serves to keep trading spreads tight and market prices close to the NAVs. For instance, the $4-billion iShares Core S&P 500 Index (CAD-Hedged) (XSP) lost 4.2% yesterday, closely tracking its benchmark index. It did so on trading volume of $65.2 million and 4,725 trades.
Over time, discrepancies between market prices and NAVs tend to even out, and large premiums or discounts tend to be very unusual and temporary in nature. On another trading day, the Vanguard ETF Portfolios may trade at discounts, making their cheap management fees all the more attractive.
But for any unfortunate investors who may have unknowingly bought a Vanguard ETF Portfolio this week at premiums to NAV of 5% or more, it would take considerable time for low management fees to offset the steep price of entry.
| Fund | Feb. 5 closing price |
Feb. 5 NAV close |
Premium to NAV |
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| Vanguard Conservative ETF Portfolio (VCNS) | $27.37 | $24.46 | 11.9% | ||
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| Vanguard Balanced ETF Portfolio (VBAL) | $24.85 | $24.23 | 2.6% | ||
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| Vanguard Growth ETF Portfolio (VGO) | $25.30 | $24.00 | 5.4% | ||
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| Source: Vanguard Investments Canada Inc. | |||||
