Terms of the Trade: NAV, Premiums, and Discounts

Deciphering the deluge of terms and acronyms that has accompanied the emergence of the ETF marketplace

Ben Johnson 6 May, 2010 | 3:57PM
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The emergence of the ETF marketplace has been accompanied by a deluge of different terms and acronyms that have left many investors (ourselves included) in want of a user's manual. With our body of work on the ETF Centre, we aim to piece together exactly such a resource over time to help investors use exchange-traded funds to their best advantage. Here, we will discuss net asset value (NAV): what it is, why it matters, and how to make sure you are buying shares of an ETF at a fair price.

What is NAV?
Net asset value is the total value of an ETF's assets, less the total value of its liabilities. The composition of an ETF's assets will vary, but it generally consists of stocks, bonds, or other collateral. If the fund uses physical replication to track its benchmark, the assets are the component securities (or a sampling thereof) of its benchmark index, any accrued income generated through securities lending, and some cash. If the fund uses synthetic replication (or total return swaps) to track its benchmark, then its assets will include a basket of pledged collateral securities—which may bear little resemblance to the benchmark index—any unrealised gains on the total return swap providing exposure to the index, and cash.

Liabilities for ETFs and other funds will largely consist of fees owed to the fund company, and any unrealised losses on total return swaps (which applies solely to swap-based ETFs). An ETF's NAV per share can then be calculated by dividing the total net asset value of a fund by its number of outstanding shares.

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The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Ben Johnson

Ben Johnson  is director of passive funds research at Morningstar.

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