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I hold a position in CSPX, an ETF tied to the S&P 500 traded on the LSE. The closing price of CSPX was 262.68USD at a gain of 0.2%. The S&P 500 itself closed higher at at 1.6%. There are a couple of reasons I can think of as to why they are not equal:

  1. The S&P 500, or rather the underlying assets, continued to be traded for several hours after the LSE ceased trading. If this is the case should I expect the value of the fund to rise on Monday morning?
  2. The fund manager for CSPX has elected to place more funds in some companies than others. In this case perhaps a higher tranche has gone into a company which has done poorly compared to the rest of the stocks in the index.

Generally speaking if a stock is bought a lot, the price goes up. Does the same ring true for ETFs? If a lot of people buy into the ETF will that affect the price at all or does the value of the ETF depend absolutely on the NAV of the underlying assets?

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In principle, the returns of ETFs and their underlying benchmark portfolios should be very near each other. If there is a lot of demand for CSPX, driving its price above the value of the underlying portfolio, then authorized participants can buy the basket of securities, give them to the ETF provider in exchange for new shares of CSPX, then turn around and sell them at a profit. This will drive prices down. Similarly, if CSPX falls too much, they can buy it up and exchange it for the basket of securities, which will push its price up.

ETF prices are not simply the result of demand/supply like stocks are. We don't really know what the correct price of a stock is because the cash flows for that stock are unknown, so the price is determined by demand/supply. On the other hand, we do know the correct value of an ETF in terms of the prices of its underlying securities and there is a mechanism to push the ETF price toward the "correct" price.

Ok, so what are some cases where this breaks down?

  1. There are transactions costs associated with the arbitrage I mentioned above. This usually causes only small deviations in return for a liquid index like the S&P500.
  2. If there is a big swing in demand, arbitragers could be swamped and not have enough resources (or time) to adequately correct the price. This would be a short-term phenomenon.
  3. There may be differences between the index and the basket of securities the ETF tracks. For example, if an ETF invests in the stocks in the S&P500, its return will not match the S&P500 index because the S&P500 is not a total return index--dividends are not properly accounted for in the index; also each ETF handles dividends differently. For cost-saving reasons, some ETFs also do not invest in the full basket of securities associated with the index.
  4. And the most important one in your case: closing prices in the US and Europe are not simultaneous. If you want to know whether your ETF is tracking well, you should compare its closing price to the level of the S&P500 at the time your local market closed. The S&P will have continued moving throughout the US day and could move significantly before US markets closed. If the US market is closed and you want to know whether your ETF is tracking, then look to the S&P500 futures contracts, which trade 24 hours a day. There is a little bit of drift in futures returns relative to the index (again because of dividends) but the returns of the futures contract and your ETF should be very close.

You can have an idea of what the opening price of your ETF will be in the morning by looking at what has happened in the US market and the futures markets up to that time. Of course, sometimes that opening price surprises us anyway, but we should get equal surprise in the ETF and futures contracts.

  • When you mentioned authorised participants buying a basket of securities, who are these authorised participants? – Nanor Feb 24 '18 at 23:17
  • Authorized participants are institutions that are allowed to redeem and create new shares. Who these are depends on the ETF. – farnsy Feb 25 '18 at 2:17

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