The Inner Workings of ETF’s

ETF Exchange traded fund Trading Investment Business finance concept on virtual screen

Past performance is no guarantee of future results.  Trend signals are proprietary research of Fortunatus Investments, LLC, a Registered Investment Advisor with the Securities and Exchange Commission (SEC). Reference to registration does not imply any particular level of qualification or skill.  Prior to June 2014, Fortunatus Investments was a wholly owned subsidiary of Executive Wealth Management, LLC and they continue to share common ownership and control. Data source for returns is FactSet Research Systems Inc. This chart is not intended to provide investment advice and should not be considered as a recommendation.  One cannot invest directly in an index. Executive Wealth Management does not guarantee the accuracy of this data.

Quote of the Week

My general thought would be that if you have less money than Elon, you should probably watch out. 

A comment last week on Bloomberg News from a former world’s richest man, Bill Gates, on the dangers retail investors may face in trying to emulate the financial strategies of the current world’s richest man, Elon Musk.

Market News

“The whole is greater than the sum of its parts” is a sports slogan repeated by coaches since the dawn of time. So important is this idea to our culture that numerous Hollywood movies have been made about a collection of scrappy underdogs that through some athletic alchemy brought on by self-belief and teamwork find a way to beat a more talented opponent.

Well, in the financial world, the whole is equal to the sum of its parts, at least most of the time. For example, exchange-traded funds (ETFs) allow investors to own a collection of securities wrapped up in one share.  The share is traded on an exchange allowing its price to fluctuate continuously. The sum of the values of the underlying parts of the ETF are also tracked consistently in a statistic called its Net Asset Value (NAV).

The Yahoo Finance summary page of the SPDR S&P 500 ETF (Ticker: SPY) after market close on February 26,2021. The closing price of 380.36 and the NAV of 380.56 are underlined in yellow. The ETF was trading at a 0.05% discount at this time.

When a share of an ETF is greater than (or less than) the sum of its parts, then the divergence is corrected by a process called arbitrage.  The ETF provider has designated certain parties (called the authorized participants) to correct the discrepancy.  The authorized participants, usually large investment banks, have the ability to adjust the number of shares of the ETF so that its supply and demand will meet at price very close to the sum of its individual parts. When the ETF shares are cheaper than its NAV (called trading at a discount), the authorized participants will redeem shares with the ETF provider in exchange for the more valuable basket of underlying securities. When the ETF shares are more expensive than its NAV (called trading at a premium), the authorized participants will give the ETF provider a basket of securities in exchange of a new more valuable share of the ETF. This way the price of the ETF is should always be closely aligned with the sum of the prices of its individual parts. 

But what happens if it is difficult to value the individual parts? In sports, who is the greatest quarterback has been a perennial topic of debate. One reason for the constant contention is that the value of a quarterback can’t be easily reduced to measurable quantities like how far he can throw a football or how fast he can run a 40-yard dash.  There are intangible qualities like leadership and composure that are difficult to quantify. Given such a conundrum, people tend to judge quarterbacks by the success of their teams. The value of the whole (the team) is used to to tell us something about the value of the individual parts (the quarterback in this case). Despite producing mediocre individual data during the NFL combine, Tom Brady is considered by many the greatest quarterback in NFL history because he has led the most Super Bowl winning teams.

A similar situation can occur in the financial world during volatile markets. If a security hasn’t traded recently due to its illiquidity or some market restriction, then an accurate up-to-date value can be uncertain. In many such cases, ETFs that contain the security continue to trade in the markets. In these situations, the price of a share of the ETF can vary widely from its NAV. The price of the ETF is giving the market a sense of the underlying securities’ total value that the NAV (which may consist of out-of-date prices) does not. In February and March of 2020, fixed income ETFs traded at a steep discount to their NAVs during the sharp market downturn.  The ETF prices were signaling a fear about the ability of companies  to repay their debts that wasn’t being conveyed in the individual illiquid bond prices.  And last month, XRT, the largest mall-retailer ETF, held an unusual 3% discount to its NAV as trading in its largest holding, GameStop Corp., was halted by the exchange on several occasions due to its volatility.  Trading in XRT was never stopped and its NAV discount may have indicated that the bearish sentiment on GameStop was greater than the market could handle at that time. So, whether in sports or finance, the relationship between a whole and its parts isn’t always simple arithmetic.


Model Update

On Friday, February 26th, all three Fortunatus Equity models made adjustments to their underlying holdings.  The Emerging Growth Companies model increased its allocation to the Healthcare sector. The Equity Dividend model added a new position in the Financial Services industry; and the Equity Growth model rebalanced two positions that had drifted out of range.

There were no other trades in the Fortunatus models during the week ending on February 27th, 2021.  The major equity market sectors remain in a long-term favorable trend, and the Fortunatus Asset Allocation models are near their maximum allowable equity exposure with domestic stocks favored over international shares.

EWM News

Executive Wealth Management invites you to attend its VIRTUAL 2021 Economic Forum entitled “Data-Driven Decisions” on Monday, March 15, 2021, from 4:00 PM to 5:30 PM EST. The online event will feature nationally recognized speaker and economist Alex Chausovsky.  The forum will explore all  the changes that have occurred in the economy and what they mean to your future with the ability to ask questions in real-time. 

Click On This Link To Register Today.

Alex Chausovsky is an accomplished speaker and serves as Senior Business Advisor at ITR Economics™.

A highly experienced market researcher and analyst, he has more than a decade of expertise in subjects that include macroeconomics, industrial manufacturing, automation, and advanced technology trends. Alex has advised companies throughout the US, Europe, Brazil, China, and Japan for 15 years. He has also been featured on NPR, the BBC, and in The Wall Street Journal.
Alex Chausovsky ITR Economics Speaker

Executive Wealth Management (EWM) is a Registered Investment Advisor with the Securities and Exchange Commission. Reference to registration does not imply any particular level of qualification or skill. Investment Advisor Representatives of Executive Wealth Management, LLC offer Investment Advice and Financial Planning Services to customers located within the United States. Brokerage products and services offered through Private Client Services Member FINRA/SIPC. Private Client Services and Executive Wealth Management are unaffiliated entities.  EWM does not offer tax or legal advice. Please do not transmit orders or instructions regarding your accounts by email.  For your protection, EWM does not accept nor act on such instructions. Please speak directly with your representative if you need to give instructions related to your account. If there have been any changes to your personal or financial situation, please contact your Private Wealth Advisor.

Returns are calculated as indicated below with reinvested dividends not considered except for the Barclays U.S. Aggregate Bond Index. Data source for returns is FactSet Research Systems Inc. The London Gold PM Fix Price is used to calculate returns for gold

1 Week = closing price on February 19, 2021 to closing price on February 26, 2021

 1 Month = closing price on January 26, 2021 to closing price on February 26, 2021

 3 Month = closing price on November 25, 2020 to closing price on February 26, 2021

 YTD = closing price on December 31, 2020 to closing price on February 26, 2021

All information and opinions expressed in this document were obtained from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to its accuracy or completeness. All information and opinions as well as any prices indicated are current only as of the date of this report, and are subject to change without notice. Material provided is for information purposes only and should not be used or construed as an offer to sell, or solicitation of an offer to buy nor recommend any security. Any commentaries, articles of other opinions herein are intended to be general in nature and for current interest. Some of the material may be supplied by companies not affiliated with EWM and is not guaranteed for accuracy, timeliness, completeness or usefulness and EWM is not liable or responsible for any content advertising products or services.

Check the background of this firm on FINRA’s BrokerCheck.