Watch Out For the Country ETF Premium Delayed Effect

Because some exchange-traded funds hold baskets of foreign stocks that trade as an ETF basket during American market hours while their own market is already closed, some odd situations can develop which can work against your global ETF portfolio.

Take last Friday for example. On Friday, international markets were generally down. The Nikkei index fell very sharply by -5.42% due to the general concern about growth and earnings seen in other stock markets combined with worries about threats to Japanese exporters tied to the sharp rally that has been seen in the yen in the past week. South Korea took a hit of -3.29%, but other Asian stock markets saw losses of less than 2%.

US markets got a shot in the arm Friday morning with the discount rate cut and many stocks, including international ETFs, were off to the races. But wait a second, how can the companies in the ETF basket be trading at higher prices than that which the underlying companies just closed at in their home markets?

Let's take the South Korean iShare ETF (EWY) as an example. The leading companies in this ETF such as Samsung and Posco lost ground in the Seoul market with the ETF as a whole losing 2.7% of its net asset value. But the Korean ETF rode the surge during Friday's rebound finishing up for the day 3.94%. Investors are clearly paying a premium to the underlying net asset value of the basket of companies that are in the ETF.

Institutional investors note this value gap and move into action. They take the underlying stocks in the Korean ETF, deliver them to Barclays Global investors and in turn, receive iShares units which are injected into the market, bringing supply and demand into closer sync and the price of the ETF basket closer to its net asset value. Watch what happens when EWY opens Monday morning.

The key is be wary of buying into these ETFs on days like Friday and instead sell into sharp upticks and keep up on how these foreign markets closed.

Comments

[mylittlebut...:]

great post - I just switched out of a Korea mutual fund into EWY and had to deal with this first hand

2007 Aug 20 03:50 PM