Beyond Bulls & Bears


Diving into the ETF and Mutual Fund NAV Pool

With many mutual funds converting into exchange-traded funds (ETFs), the combination of ETF trading and net asset value is garnering more attention. David Mann, Head of Global ETF Capital Markets, dives in.

My original blog (ETF Capital Markets Corner) has been around since 2016. For those who have been reading from the very beginning, you are very aware of the amount of ink spent discussing and debating some of the misconceptions regarding exchange-traded fund (ETF) liquidity. I would like to think that this audience—and investors more broadly—are now more comfortable trading newer funds, irrespective of their size or trading volume.

One of the points I made when highlighting the flaws of using average volume as a liquidity metric was that ETF net asset value (NAV) trades do NOT count in the official volume calculations. (See my prior posts, When Volume Doesn’t Tell the Whole Story and Revisiting (Again!) the Problems of ETF Volume).  Not only does trading volume ignore how much the underlying basket of the ETF trades, but it also ignores a potentially large pool of block trades executed in the NAV markets.

Missing from those posts was a broader discussion on the NAV trades themselves. This is a topic that is starting to get a bit more attention, especially now that mutual funds have begun converting to ETFs and those mutual fund investors are accustomed to trading at NAV.

Before I dive into the different flavors of ETF NAV trading, let’s first review the reasons investors love ETFs (and why mutual funds are being converted to them). I think these are my top four:

  • Tax efficiency
  • Low costs
  • Daily transparency
  • Intraday trading

For the first two reasons, other things being equal, you most certainly would prefer your investment be tax efficient and low cost than tax inefficient and expensive. For the last two, there is a real possibility that you shrug your shoulders at one or both. For daily transparency, I am sure there are plenty of investors who are not checking the portfolio holdings every single day. For many long-term investors, the value of intraday trading is minimal at best.

We can apply that last point to mutual fund investors, especially those who might be entering the ETF world for the first time. Mutual fund investors are not concerned with intraday trading because that is not how they work! We often say that ETFs are like mutual funds except you have the option to trade at any point during the day. But no one says you need to exercise that option.

Thus, for this effort, let’s discuss how we can make the ETF trading experience just like the mutual fund investment experience. My basic understanding of buying an equity mutual fund:

  • No matter what time the order is submitted during the trading day, the investor gets that day’s NAV.
  • For mutual funds that hold US stocks, that NAV will be based on the closing price of those US stocks.
  • For mutual funds that with international holdings, there might be a fair value adjustment to those international stocks when calculating the fund’s NAV.

ETF intraday trading is simply a mix of those three elements continuously calculated throughout the day. To understand the intraday price of an ETF, start with the value of the underlying stock and then adjust for closed international equity markets as needed (in the ETF world we call this “price discovery.”)

For an ETF to have that mutual fund feel, investors want that last closing price no matter what time they submit their order during the trading day. To achieve this, investors need to use a market-on-close (MOC) order type to buy or sell at last closing price.

Thus, for mutual funds that might make sense within an ETF wrapper, it’s imperative for the ETF issuer to work with both the listing exchanges and ETF market makers to ensure that the MOC order works as intended. I talked about closing auctions during the Market Structure Madness event of 2018, and these order types can work great when ETF market makers are prepared for them. The end (of day) result is that instead of buying a mutual fund for a certain amount of dollars, you will buy a certain number of shares of an ETF using the MOC order. For advisors who are not as familiar with trading ETFs, their overall experience should be the same.

One last point before wrapping up this discussion. The MOC order is different than trading at NAV. NAV trades (as the name suggests) are usually larger size trades whose price is based on the ETF’s official NAV. Typically, the official NAV is not known until very late on the day of trading. Thus, NAV trades are printed before the market opens on the next trading day, which, back to my earlier comment, is why they do not count as part of the ETF’s official trading volume.

Both MOC and NAV trades have their uses for all investors. However, for current mutual fund investors making their first leap to ETFs, it is the MOC order that will likely make them feel most at ease.

What Are the Risks?

All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Generally, those offering potential for higher returns are accompanied by a higher degree of risk.

For actively managed ETFs, there is no guarantee that the manager’s investment decisions will produce the desired results.

ETFs trade like stocks, fluctuate in market value and may trade above or below the ETF’s net asset value. Brokerage commissions and ETF expenses will reduce returns. ETF shares may be bought or sold throughout the day at their market price on the exchange on which they are listed. However, there can be no guarantee that an active trading market for ETF shares will be developed or maintained or that their listing will continue or remain unchanged. While the shares of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.

Important Legal Information

This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. This material may not be reproduced, distributed or published without prior written permission from Franklin Templeton.

The views expressed are those of the investment manager and the comments, opinions and analyses are rendered as at publication date and may change without notice. The underlying assumptions and these views are subject to change based on market and other conditions and may differ from other portfolio managers or of the firm as a whole. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region or market. There is no assurance that any prediction, projection or forecast on the economy, stock market, bond market or the economic trends of the markets will be realized. The value of investments and the income from them can go down as well as up and you may not get back the full amount that you invested. Past performance is not necessarily indicative nor a guarantee of future performance. All investments involve risks, including possible loss of principal.

Any research and analysis contained in this material has been procured by Franklin Templeton for its own purposes and may be acted upon in that connection and, as such, is provided to you incidentally. Data from third party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data.  Although information has been obtained from sources that Franklin Templeton believes to be reliable, no guarantee can be given as to its accuracy and such information may be incomplete or condensed and may be subject to change at any time without notice. The mention of any individual securities should neither constitute nor be construed as a recommendation to purchase, hold or sell any securities, and the information provided regarding such individual securities (if any) is not a sufficient basis upon which to make an investment decision. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user.

Products, services and information may not be available in all jurisdictions and are offered outside the U.S. by other FT affiliates and/or their distributors as local laws and regulation permits. Please consult your own financial professional or Franklin Templeton institutional contact for further information on availability of products and services in your jurisdiction.

Issued in the U.S. by Franklin Distributors, LLC, One Franklin Parkway, San Mateo, California 94403-1906, (800) DIAL BEN/342-5236, – Franklin Distributors, LLC, member FINRA/SIPC, is the principal distributor of Franklin Templeton U.S. registered products, which are not FDIC insured; may lose value; and are not bank guaranteed and are available only in jurisdictions where an offer or solicitation of such products is permitted under applicable laws and regulation.


Get Content Alerts in My Inbox

Receive email alerts when a new blog is posted.