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MSCI thematic ETF research identifies transaction costs as a leading indicator of price deviation

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Research from MSCI evaluating the relationship between ETF prices and Net Asset Value (NAV) reveals how ETF investors can better manage the risk involved with discrepancies between those two figures. 

Author Laszlo Hollo writes that as thematic equity ETFs have grown in popularity, concerns have been raised about their liquidity – especially when an ETF holds a large fraction of a constituent’s shares. In particular, because of the mechanics of ETFs, investors are free to transact intraday in the fund, but the underlying equities may struggle to keep up with the fund’s trading activity. This liquidity mismatch could lead to a gap between the ETF price and the net asset value (NAV) of the fund, Hollo says. This gap can also be sizeable: For some funds the price-NAV difference reached 8 per cent-10 per cent during the COVID-19 crisis, while transaction-cost estimates reached 1 per cent-2 per cent. How can ETF investors get a handle on this risk, Hollo asks.

The research identifies transaction costs as a leading indicator of ETF price/NAV deviation, particularly among lower-volume exchange traded products and funds that own a high ratio of the constituents’ stock. 

The research looks at a sampling of thematic equity ETFs with between USD1 and USD20 billion in AUM, using MSCI’s RiskMetrics tool and historical fund-flow data. The findings may suggest even though ETF prices remain close to the NAV most of the time, investors can use a transaction-cost analysis model to gauge specific price-NAV risk of their ETF holdings.

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