Many ETFs Don’t Give You the Return You’re Expecting
Thursday, August 4, 2016

One of the characteristics that is supposed to differentiate exchange-traded funds—and other exchange-traded products, such as exchange-traded notes (ETNs)—from closed-end funds is better pricing. A closed-end fund, which does not alter its share count except for rare secondary offerings, often trades at a premium or discount to the net underlying value of its assets (aka net asset value). ETFs, in contrast, are open-ended funds. They constantly issue and redeem shares. This process is intended to limit any pricing discrepancies. In other words, when you buy an ETF, you are supposed to get the return of the assets the fund in invests in.

This is often not the case. I looked at the difference in 12-month market and net asset value returns for over 1,600 ETFs. (I’ll use the abbreviation ETF to refer to all exchange-traded products, including ETNs.) The market return for nearly one out of five ETFs (19.4%) was more than a full percentage point different than the return of the fund’s underlying net assets for the 12-month period ended June 30, 2016. Worse yet, the difference was greater than five percentage points for 39 funds. Not a 5% difference, but a full five percentage points of difference (e.g., DB Gold Double Long ETN (DGP) had a 12-month market return of 25.7% and a NAV return of 20.7% through June 30, 2016).

I’ll explain the terminology and some of the more common characteristics of the offenders in a moment. Before I do, I want to point out that not every ETF succumbs to the pricing error. Slightly more than 500 funds—representing nearly a third of all ETFs with 12-month return data—either had market returns that matched their net asset value or were within 0.1 percentage points of it. Investors who owned these funds got the returns of the underlying assets.

Net asset value (NAV) is what a fund’s assets are worth. The net asset value of a fund holding 100 stocks and a relatively small amount of cash will be the current portfolio-weighted value of those 100 stocks plus the cash. Mutual funds trade at NAV because shareholder purchases and sells are made at the end of the day. This process allows the mutual fund companies to determine the prices at which shareholder transactions will occur based on the end-of-day value of the underlying assets.

ETF prices, in contrast, change in real time throughout the trading day. Unlike mutual funds, which are bought from and sold back to the mutual fund company, ETFs are bought from and sold to other investors on the open market. Only authorized participants (large trading firms, market makers, large financial institutions, etc.) directly transact with the ETF provider. Authorized participants exchange creation units (generally blocks of 50,000 shares), a basket of securities mimicking the creation unit or, in some cases, the equivalent value in cash with the ETF provider. This process is intended to wring out pricing efficiencies by giving authorized participants the ability to take advantage of any premiums or discounts to NAV that arise.

Because we individual investors buy and sell ETFs on the open market, we realize the market return. The market return is the change in an ETF’s share price plus any distributions paid to shareholders. The net asset return, in contrast, is the return realized by the fund’s underlying assets. As stated above, there was either no difference or just very little difference between the 12-month market and NAV return for 504 ETFs. These ETFs tended to be the large funds with median assets of $467 million. Four of the largest ETFs —SPDR S&P 500 ETF (SPY) , iShares Core S&P 500 (IVV), Vanguard Total Stock Market ETF (VTI) and Vanguard 500 ETF (VOO) —all closely track their NAV. iShares MSCI EAFE's (EFA) market return was 0.7 percentage points different than its NAV return. (I calculated the median instead of the average total assets to avoid having the largest ETFs skew the number upwards.)

The 319 ETFs whose market returns were more than a full percentage point different than their net asset value were considerably smaller. Their median total assets were $10.0 million, far below the median $98.3 million for all ETFs with 12-month returns. They also traded less frequently, with a median average daily trading volume of 10,000 shares versus 98,300 for all ETFs with 12-month returns. Roughly two-thirds were open-ended funds (what most people think ETFs as being) and not debt instruments (ETNs), unit investment trusts or partnerships. Several international stock and international bond funds as well as many leveraged funds made the list. The biggest commonalities, however, were a small asset size and low trading volume.

For those of you who are curious, the worst offender was iPath® Short Enhanced MSCI Emerging Markets ETN (EMSA) which had a 12-month market return of 67.8% and a 12-month NAV return of 27.0%. The largest ETFs by total assets to make the list were iShares MSCI Emerging Markets (EEM), iShares iBoxx $ High Yield Corporate Bond (HYG) and iShares Silver Trust (SLV) .

More on AAII.com

Highlights from the AAII Journal

The Week Ahead

Just 25 members of the S&P 500 will report. The only Dow Jones industrial average component will be Walt Disney Co. (DIS), which will report on Tuesday.

The week’s first financial report will be second-quarter productivity, released on Tuesday. Wednesday will feature the June Job Openings and Labor Turnover Survey (JOLTS). July import and export prices will be released on Thursday. Friday will feature July retail sales, the July Producer Price Index (PPI), June business inventories and the University of Michigan’s preliminary August consumer sentiment survey.

The Treasury Department will auction $24 billion of three-year notes on Tuesday, $23 billion of 10-year notes on Wednesday and $15 billion of 30-year bonds on Thursday.

What’s Trending on AAII
  1. Model Fund Portfolio: Introducing the Level3 Passive Portfolio

  2. 16 Financial Ratios for Analyzing a Company’s Strengths and Weaknesses

  3. The Individual Investor’s Guide to Exchange-Traded Funds 2016

AAII Sentiment Survey

The percentage of individual investors describing their short-term outlook for stocks as "neutral" is at its highest level in two months, according to the latest AAII Sentiment Survey. At the same time, optimism is back below 30%. Pessimism is lower as well.

Bullish sentiment, expectations that stock prices will rise over the next six months, declined 1.5 percentage points to 29.8%. Optimism was last lower on June 29, 2016 (28.9%). This is the 39th consecutive week and the 72nd out of the past 74 weeks with a bullish sentiment reading below its historical average of 38.5%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rose 3.1 percentage points to 43.4%. Neutral sentiment was last higher on June 8, 2016 (44.3%). This week’s increase keeps neutral sentiment above its historical average of 31.0% for the 27th consecutive week.

Bearish sentiment, expectations that stock prices will fall over the next six months, declined 1.6 percentage points to 26.8%. The decrease keeps pessimism below its historical average of 30.5% for the fifth consecutive week.

Neutral sentiment is back at an unusually high level. At the same time, fewer than 30% of individual investors describe their short-term outlook as "bullish," for the first time since the end of June. Concerns about valuations and the presidential election are having an impact, as well as headlines about the Dow Jones industrial average’s recent seven-day drop.

In addition to prevailing valuations and the election, global economic uncertainty (including Brexit) and disappointment with corporate earnings growth are giving some individual investors reasons to be cautious or pessimistic. Others feel that the perceived lack of viable investment alternatives, economic growth and generally upward momentum in stock prices will result in higher stock prices over the next six months.

This week’s special question asked AAII members what their comfort level is with the current valuations of stocks. Slightly more than half of all respondents (51%) described valuations as being too high. Among the reasons cited were insufficient earnings growth to support the valuations, slow economic growth, and current valuations being higher than historical norms. Several respondents described themselves as “uncomfortable” and/or they thought that current monetary policy is inflating valuations. An additional 14% expressed concern about the market’s short-term direction. About 16% said stocks are fairly valued or said they are otherwise comfortable with valuations. Only 12% of respondents to this week’s special question described themselves as comfortable with current valuations or don’t think prevailing valuations will hinder stocks from rising. Uncertainty surrounding the election was mentioned by many respondents.

Here is a sampling of the responses:

  • “I think stocks are now fairly valued, but there is a very wide variation in P/E ratios.”
  • “Not comfortable at all. The stock indexes are too high based on fundamental valuations.”
  • “Expensive, but little alternatives for investment.”
  • “Cautious. Valuations are high and earnings are not keeping track with stock prices.”
  • “I think the election is the big elephant in the room.”


This week’s Sentiment Survey results:

Bullish: 29.8%, down 1.5 points
Neutral: 43.4%, up 3.1 points
Bearish: 26.8%, down 1.6 points

Historical averages:

Bullish: 38.5%
Neutral: 31.0%
Bearish: 30.5%
Take the Sentiment Survey.

AAII Asset Allocation Survey

Individual investors held their largest exposure to fixed-income investments in more than three years, according to the July AAII Asset Allocation Survey. Equity allocations were unchanged, while cash levels rose.

Stock and stock fund allocations stayed at 64.1% for a second month. July was the 40th consecutive month equity allocations were above their historical average of 60.5%.

Bond and bond fund allocations rebounded by 0.6 percentage points, to 18.0%. Fixed-income allocations were last higher in May 2013 (18.1%). The rise keeps bond and bond fund allocations above their historical average of 16.0% for the 12th consecutive month.

Cash allocations declined 0.6 percentage points, to 17.9%. June was the 56th consecutive month with cash allocations below their historical average of 23.5%.

There has been an overall increase in fixed-income exposure this year, particularly to bond funds. Relative to the range recorded for the current three-year period, six of the eight months with the highest fixed-income allocations were in 2016. This trend has occurred as optimism about the short-term direction of the stock market has remained below average for 38 consecutive weeks.

The ongoing investment environment remains tough for individual investors. Yields are low, while valuations for both stocks and bonds are elevated.

July’s special question asked AAII members how Great Britain’s decision to leave the European Union affected their allocation decisions. Nearly three-quarters of respondents (73%) said the referendum’s outcome either did not affect their portfolio allocation decisions or that they are not making any changes in reaction to the vote. Some of these respondents viewed the vote as a short-term event, said they are waiting to see what happens in the future or explained that the vote doesn’t change their long-term strategy. Slightly more than 10% of respondents said they either reduced, are holding off or are more cautious on international investments, with some specifically mentioning British companies.

Here is a sampling of the responses:

  • “Has not affected my allocation.”
  • “Increased caution regarding international stock allocations.”
  • “Not much; generally have maintained the same asset allocation.”
  • “So far no effect. It will be some time before the terms for the withdrawal from the EU will be decided.”
  • “I reduced foreign holdings and increased domestic stock holdings.”
July AAII Asset Allocation Survey results:

  • Stocks and Stock Funds: 64.1%, no change
  • Bonds and Bond Funds: 18.0%, up 0.6 percentage points              
  • Cash: 17.9%, down 0.6 percentage points

July AAII Asset Allocation Details:

  • Stocks: 29.3%, down 1.2 percentage points
  • Stock Funds: 34.9%, up 1.2 percentage points
  • Bonds: 3.3%, down 0.3 percentage points
  • Bond Funds: 14.7%, up 0.9 percentage points

Take the Asset Allocation Survey.


Local Chapter Meetings
AAII Local Chapter Meetings offer you a variety of presentations from expert speakers who will give you their view on the world of investing. A bonus of attending a Chapter Meeting near you is the opportunity to meet other AAII members who share your interest and enthusiasm for investing. You can even share the Chapter experience with your family and friends by inviting them to attend Chapter Meetings with you!