Those interested in ESG investing have long known that a lack of standardization is standing in the way of its wider adoption. And as it turns out, the absence of a common standard is also problematic for a much broader investment space.
“[Investors and ETF asset managers] want to compare ETF performance, to see how their fund did versus its competition,” noted Elizabeth Kashner, director of ETF Research and Analytics for FactSet. “Shockingly, it is nearly impossible to make a fair, apples-to-apples comparison within an ETF market segment.”
According to Kashner, the most reliable among the different metrics of ETF performance is the end-of-day net asset value (NAV), but it can be calculated in two valid, conflicting ways. “NAVs can be designed to minimize calculated tracking difference or premium/discount,” she said, explaining that ETF asset managers must choose one NAV accounting method to set each portfolio security’s closing price, along with a time of day for foreign currency conversions.
One method, aligning strike times to capital-market closings, may minimize premiums/discounts, but it can create problems with tracking difference. By a similar token, synchronizing NAV with benchmark valuations tightens tracking difference; however, it blows out premium/discount results because all currency valuations happen at 4 PM ET, Kashner said. That means major asset classes including international equity, all fixed income, commodities, and currencies have overstated tracking error or trading costs.
“The different NAV calculation styles make a direct comparison of fund returns between major issuers impossible,” Kashner noted. “Return differences might be explained by FX conversion times rather than by economic exposure.”
She added that most asset managers do not disclose which method they go with. Not only does it leave investors to assume the worst for fund efficiency or tradability, but it also makes apples-to-apples performance comparisons problematic.
Theoretically, an alternative to NAV-based comparisons could be to look at a fund’s closing market price, since market forces should value any two given portfolios in the same way and ETFs trade until the closing bell rings. But some ETFs see thin to no trading, which means their pricing is often stale and not reflective of their current market value.
One other approach, Kashner said, could be to reference each fund’s underlying index, adjusting performance based on median tracking difference. But most index data is only accessible with a paid license, and index calculation methodologies can differ, particularly with regard to their treatment of foreign withholding taxes.
To make performance reporting clear, she recommended that any given ETF should have two NAV series published: one synchronized with the underlying index methodology, and the other with the securities markets. That way, investors could choose and use the appropriate measure to evaluate tracking differences and end-of-day premium/discount.
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