Foreign Vanguard ETF conversion- Premium is disturbing

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Foreign Vanguard ETF conversion- Premium is disturbing

Postby boggler » Thu May 09, 2013 8:51 pm

I'm planning to buy some of the Vanguard Total World Stock Index fund. I'd like to own the ETF since it has a much lower expense ratio.

I have two options:
1 - Buy the ETF directly. (VT)
2 - Buy the mutual fund (VTWSX) and immediate ask Vanguard to do the conversion to the ETF.

Vanguard's site states that there is a $0.13 premium on the ETF right now. Does this mean that it would be strictly better for me to buy the mutual fund and ask for a conversion? Does the conversion happen at NAV? If I'm buying, say, 1000 shares, that's a difference of $130!

I feel like I'm missing something here. If this is really true, couldn't some trader just buy a lot of the mutual fund, convert, and then sell the ETF for a "free money" gain? I feel like this problem shouldn't exist in an efficient market.
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Re: Foreign Vanguard ETF conversion- Premium is disturbing

Postby Dale_G » Thu May 09, 2013 9:35 pm

When I converted a different fund many moons ago, the conversion was done at NAV. You can call Vanguard to make sure, but I would bet the policy has not changed.

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Re: Foreign Vanguard ETF conversion- Premium is disturbing

Postby boggler » Fri May 10, 2013 10:05 am

So it seems like if you're planning to buy a Vanguard ETF with a premium (which many have), you'd be better off buying the mutual fund and converting, right?
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Re: Foreign Vanguard ETF conversion- Premium is disturbing

Postby psteinx » Fri May 10, 2013 10:46 am

It is quite possible that any apparent premium (or discount) is largely a phantom.

Foreign markets generally close at different times from U.S. markets. I'm not sure how Vanguard handles the timing discrepancy, but it is possible that an apparent premium/discount is a timing artifact. i.e. Let's say that after the Asian and European markets closed, the U.S. markets rallied sharply. Investors would reasonably expect that when the foreign markets next open, they will also be up, and thus would bid up proxies for those markets that trade on U.S. markets (including, presumably, a world ETF that includes a substantial allocation to Europe and Asia).

That's not to say that there's not a possibility that one fund class (ETF or traditional OEF) may not be advantageously priced relative to the other, at least at times. But understand that it's not necessarily a simple issue...

Do a search for "fair pricing" + international + fund or something like that and you can probably find more on this topic. It's been an issue with foreign funds of various sorts for some time.
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Re: Foreign Vanguard ETF conversion- Premium is disturbing

Postby lazyday » Fri May 10, 2013 10:56 am

Vanguard's site said there was a premium, but at what time was there a premium? At about the time that the US market closed?

If so, then it is a bit complicated.

If there is a premium at a time when foreign markets are open, and you can capture that premium, fine. But if those foreign markets are closed and US markets are open, and the world changes, and US stocks trade and change prices, that premium might be an illusion.

This is complicated by some foreign markets being open at times, and some being closed. Some foreign stocks trade in the US, some don't. Some trade in US as ADRs. Some foreign stocks trade on other foreign exchanges. Some trade on other foreign exchanges as GDRs.

A sophisticated investor can make estimates of value using this data, and estimate the value of stocks that are not currently trading such as by comparing other similar stocks from other countries that are trading. They can then decide if the premium is really a discount, or if the premium is really a larger premium, etc. When the US market is open they can trade the ETF, using underlying shares and the trading basket, making profit. In theory, this should keep the premium/discount low. But only low enough to pay their costs plus a profit. It is expensive to trade underlying foreign shares. Vanguard can probably step in too to keep the discount/premium from being too high; I'm not aware of methods, but since they have the dual structure, there may be ways, and they might even benefit the funds. They also have motivation to protect customers, though I suspect that ETF traders may be low on that list.

If there is demand for an ETF, there might be a small premium. If people are selling it, there might be a small discount. I don't mean the premium or discount you see, I mean after accounting for the true fair market value of the underlying shares, which will really be a matter of opinion when foreign markets are closed. This is because the manner of accounting for the shares which are not trading anywhere can be handled in different ways by different analysts.
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Re: Foreign Vanguard ETF conversion- Premium is disturbing

Postby dumbmoney » Fri May 10, 2013 3:39 pm

It's normal for an ETF experiencing inflows to trade at a premium. The premium pays the arbitragers to acquire shares and deliver them to the fund.

Although it's not easy to tell whether there's a premium _right_now_ for the reasons lazyday cited, one can play the odds. If an ETF has in the recent past consistently traded at a premium (which you can find out from Vanguard or other sources), that's the way to bet.
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Re: Foreign Vanguard ETF conversion- Premium is disturbing

Postby lazyday » Sat May 11, 2013 4:38 pm

I wouldn't assume that seeing a premium most of the time means it is likely to represent a true premium.

In a rising market, there would likely often be a premium shown, for reasons mentioned earlier.

But a premium compared to fair market value? Maybe or maybe not.

There are likely many other complications. Something I neglected to mention is compensation for risk. There may also be incentive to alter prices at approximate market closing times. This may not be legal, and may not happen in Vanguard ETFs, but I have seen it years ago in closed end funds, it was obvious. The data reported in newspapers and online was (and is) based on closing prices, so that hid the profits that were being made/taken during the day. Those not in the business cannot understand everything that happens.

Don't forget your own risk. I prefer the non-ETF class for most funds, because I see them as avoiding some of these kinds of trading risks. Here it is possible to be slightly ripped off by traders trying to game the system, but Vanguard has policies to severly limit such practices. I believe risks are much higher in ETFs, and probably not very high there. (In ETFs, I don't think the risks are profiteers or cheaters, but unexpected costs of illiquidity, of the EFT and more importantly the underlying. Traders/arbs with more information than me who can profit from me fight over these profits and keep the price somewhat close to fair--hopefully.) For highly volatile funds like REITS which have moved ~10% in one day, I have used ETFs so I can trade midday. Most funds I don't expect to wish to trade midday.

If you convert to ETF you cannot convert back, and it will be sold someday by someone. Vanguard changes their funds now and then, and it is possible for some funds to shrink or have outflows when this happens (and even when it doesn't) perhaps causing illiquidity and/or discounts to fair value in the ETF.
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Re: Foreign Vanguard ETF conversion- Premium is disturbing

Postby lazyday » Sat May 11, 2013 4:48 pm

Note that my posts ignore expense ratio.

Where ETF expense ratio is significantly lower, and holding period is long, the ETF should be better I think.

In the uncommon case where both this is true and one can also convert for free (maybe OP) then perhaps it might make sense to convert...I am not certain and this is not something I've put much thought into.
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Re: Foreign Vanguard ETF conversion- Premium is disturbing

Postby dumbmoney » Sat May 11, 2013 7:00 pm

lazyday wrote:I wouldn't assume that seeing a premium most of the time means it is likely to represent a true premium.


Not sure what you mean by true premium. The NAV may be wrong, but it's still the price at 4PM. Unless the ETF trades very differently at 4PM than at other times, it's valid information.
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