What went wrong on June 4, 2024, and June 5, 2024 with ETFs?
As per a head of passive investments of a mutual fund house, Indian stock market was not ready for such a big volatility and thus the NAV of ETFs varied from their iNAV price by a big margin.
Zerodha said on X (formerly Twitter) on June 5, 2024, “Many ETFs seem to be trading at a big premium or discount to their benchmark. Please keep these things in mind before buying and selling ETFs. Whenever there are sharp moves in the markets, ETFs can trade at abnormal premiums or discounts.”
Here’s the reason:
Market makers of ETFs had insufficient capital: “Market markets had insufficient capital to support such large, unusual volatility. AMCs use market makers to provide liquidity to buyers and sellers. Say you place a buy order for 1 crore worth of ETF units and hence place an order. But an AMC is managed by Trusts, who cannot generate units on their own, so this is where a market maker comes into play. Market makers will pay the AMC Rs 1 crore and then the AMC will generate the ETF units of equivalent value and then the buyer will get delivery after T+2 days,” said the head of passive investments of a mutual fund house.
Supply and Demand: “Like any security, ETFs trade based on supply and demand in the market. If there are more buyers than sellers (high demand), the price can rise above the iNAV (premium). Conversely, if there are more sellers than buyers (oversupply), the price can fall below the iNAV (discount),” says Amit Goel, Co-Founder and Chief Global Strategist, Pace 360, an investment firm.
Market Anticipation: “If investors anticipate that the underlying assets in the ETF will rise in price soon, they might be willing to pay a premium over the iNAV to get in early. On the other hand, if a decline is expected, they might sell their holdings, driving the price down to a discount,” says Goel.
“There are three popular market makers in India: Parwati Capital, East India Securities and Kanjalochana Finserve. All the AMCs mostly use these three brokers for market making purposes of its ETFs. Almost 80% of the market making activities for an ETF is done by East India Securities and 20% by others. I don’t have the exact figure but roughly East India Securities can deploy 500 crores a day for providing liquidity to all the ETFs. On days like Budget, Election results, RBI MPC, etc usually markets get into a panic mode and investors get jittery. Rs 500 crore is not that large amount of money in such volatile days, so yesterday this is what happened. Whatever capital these market makers had, got exhausted. This is why NAV of ETF units got haywire. On usual trading days this problem is non-existent,” says the head of passive investments of a mutual fund house.
What is the solution to this problem?
As per the head of the passive investments of the mutual fund house, the solution to this problem could be to encourage more active participation of stockbrokers as market makers. “SEBI should also allow AMCs to do market making on their own. Mutual fund schemes have AUM so SEBI should allow the mutual fund scheme to create units in ETFs,” the person cited above said.
To invest in an index like Nifty 50, Bank Nifty, Nifty Midcap 150, etc you either need to buy an exchange traded fund (ETF) which is tracking the respective index or invest in an index mutual fund which is tracking such an index. The value of all shares and cash held by an ETF when divided number of outstanding shares of ETF is called NAV of that fund. A mutual fund is typically purchased or sold at its day end NAV price, whereas an ETF is purchased or sold on stock exchanges close to its real-time NAV.
How does NAV work for mutual funds and ETFs?
As per a SEBI circular dated May 23, 2022, mutual fund houses must publish indicative NAV (i-NAV) on its website for ETFs. i-NAV is the real time value of one unit of the ETF shown during trading hours. However, the price you see on the stock market is the market price of the said ETF. The market price of an ETF depends on various factors like volatility, demand, news, etc. If there is high volatility in the market the price of ETF is bound to fluctuate very rapidly based on changes in the prices of underlying shares.
As per Kshitiz Jain, CFA FRM, Co-Founder,CAGRfunds, a wealth management company, “For equity ETFs, the i-NAV would be declared within a maximum time lag of 15 seconds from the underlying market. For debt ETFs, the i-NAV would be declared at least four times in a day with a minimum time lag of 90 minutes between the two disclosures.”
How much did the indicative NAV of ETF vary from their real time price?
The Securities and Exchange Board of India (SEBI) mandated every mutual fund company to publish its ETF scheme’s indicative NAV (iNAV) on its website. The iNAV of an ETF can help investors gauge the value of the ETF before buying or selling it. For example, the iNAV of JUNIORBEES as of June 5, 2024, 8pm is Rs 710.5366, as per Nippon Mutual Fund website. However, the closing price of NIFTYBEES on June 5, 2024, on National Stock Exchange (NSE) was Rs 713 as of 3.30 pm.
As per data shared by Zerodha on X (formerly Twitter) JUNIORBEES had an iNAV of Rs 699.85 at a particular point of time on June 5, 2024, however it was being traded at Rs 705.08 at that time. So, if you wanted to buy JUNIORBEES you had to pay Rs 5.23 (approx) extra per unit of the ETF.
Picture showing the real time NAV of some ETFs. Source: Zerodha on X.
Picture showing the real time iNAV of some of the ETFs. Source: Zerodha on X.
How to check i-NAV of ETFs?
Every mutual fund company published its ETF’s i-NAV value on a real time basis on its website. For example: Nippon Mutual Fund’s i-NAV can be viewed here: https://mf.nipponindiaim.com/FundsAndPerformance/Pages/INAV.aspx
Motilal Oswal: https://www.motilaloswalmf.com/etf
Some stock brokers like Zerodha also show the i-NAV price on its app. “To add iNAVs to your Kite marketwatch search for ETF Name NAV,” said Zerodha on X.
Motilal Oswal Mutual Fund
Source: Motilal Oswal website as of June 5, 2024 9.22pm
What should you do if you want to invest in ETFs?
There are two sets of investors- short term traders and long-term investors. Experts advise what both of these investors should do in such situations.
Long term investors: As per Jain, before buying or selling an ETF, you should compare the i-NAV with the market NAV price of the ETF. While buying the ETF check if the market price is lower or close to the I-NAV price and while selling check if the price is higher or close to the i-NAV price. For retail investors, it would be advisable to invest via the index mutual fund route instead of the ETF. “The buying and selling in an index fund would be done as per the day-end NAV of the fund, so the investor need not worry about the intraday price movement or the mismatch between i-NAV or market price,” he says.
Stock market traders: “When authorised participants create or redeem large ETF blocks, temporary imbalances between supply and demand can arise, causing short-term premiums or discounts. The price discrepancies between iNAV and market NAV price can present arbitrage opportunities for sophisticated traders. Arbitrage involves exploiting price inefficiencies across markets to lock in risk-free profits,” says Goel.
