Yesterday I was going through a video by Pattu Sir on ETFs and Index Funds. It talked mostly about Price NAV difference. The Price NAV difference primarily occurs due to Demand Supply dynamics that are present in an ETF. The ETF as the name suggests Exchange Traded Fund is traded in the market. Because of being a traded commodity, ETFs offer an inherent advantage for demat holders.
You can watch the video here.
The Price NAV difference of ETF is because of various factors. Therefore, to reduce this difference one has to know how this happens in the first place. The Price NAV difference and Tracking Error are the most common things in the world of Investing. The tracking error corresponds to the difference between NAV and the value of the Index. Suppose Nifty 50 is at 11,000 and the ETF is trading 1101 then the tracking error will be 1/1100 which comes to 0.09%. On the other hand, the Price NAV difference happens as a result of the price you paid is different than NAV declared. The NAV declared is inclusive of Tracking Error.
Price NAV Difference: Causes
The ETF Being traded in the market is the reason why the difference in prices and NAV exists. In case of Index Funds, one buys at NAV only. The active trading happening in an ETF causes it to swing widely. The listed nature of ETF enables an ETF to have OHLC data. Whereas NAV gets calculated based on closing prices. Due to active trading, you can buy ETFs at prices which are lower than NAV of the day.
The ETFs declare dividends from time to time. This causes divergence in the price of the index with that of ETF. Since the company in index declaring dividend and ETF declaring dividends are on different dates, the divergence causes tracking errors. The dividends cause tracking errors, and cash holding in an index fund also cause tracking error. These things don’t cause divergence in prices and NAV.
Taking advantage of divergence
The advantage of ETF is in their listed nature. In an index fund, one cannot buy at the intraday bottom created in the market. You can buy an ETF in a flash crash happening in the market. Also, the proliferation of apps and fast internet connection enables one to time with ETFs.
(See Also: My journey into Nifty Alpha 50)
Since the ETFs are actively traded, they generate OHLC data. Timing becomes easier with OHLC data as technical indicators like RSI, MACD, Bollinger Bands, Stochastic Oscillator etc.. use them. In a rising market with a bald candle, you always buy an ETF below its NAV. Similarly, in a falling market, the price will always be higher than NAV.
The timing works only if you have active buyers/sellers for your ETF.
Above all, the most important thing to look for in an ETF is its liquidity. ETFs like JuniorBees, NiftyBees, LiquidBees, BankBees swim in liquidity. Just looking at bid-ask data of ETFs during market hours will reveal the liquidity. In simple words, the timing works only if you have active buyers/sellers for your ETF.
Also, expertise is needed for timing. Plunge with caution. You need to overcome the hatred towards traders to time correctly.