Understanding the “ETF of ETFs” structure

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BogleBuddy12
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Understanding the “ETF of ETFs” structure

Post by BogleBuddy12 » Sun Jun 28, 2020 11:26 am

Hello. I am doing my best to understand ETF of ETFs. For example, BNDW (Vanguard Total World Bond ETF) is a combination of BND and BNDX.
https://investor.vanguard.com/etf/profile/BNDW

Questions:

1. If the two underlying ETFs (in this case, BND and BNDX) have huge AUM and very tight spreads, why does BNDW trade at larger spreads and have much less AUM?

2. I noticed that during periods of market crisis, BND and BNDX have been known to trade at a significant discount to NAV. It appears there were some issues during the first Covid-19 volatility. However if you look at BNDW, this has not been the case. The price has stayed relatively close to NAV. (I’m using the ETF.com information.) How is this possible if the underlying ETFs have experienced these concerns?

3. Has BNDW grown in size sufficiently or is there any closure risk? Could there be any closure risk if the two underlying ETFs are hugely popular?

4. Are there any differences to note when it comes to taxes and dividends? Does the ETF of ETFs duplicate the tax efficiency of the two underlying ETFs?

alex_686
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Re: Understanding the “ETF of ETFs” structure

Post by alex_686 » Sun Jun 28, 2020 12:06 pm

1. Because BNDW is small.

2. Yes, during the market crisis the NAVs where kicking out garbage results. ETF prices where correct. BNDW’s prices where built off the other 2 ETF prices, So that is why the were in line.

3. Don’t know. However, it will remain open as long as its is popular. The size of the 2 underlying funds do not matter.

4. No tac concerns here. Mutual funds are pass through structures.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.

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BogleBuddy12
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Re: Understanding the “ETF of ETFs” structure

Post by BogleBuddy12 » Sun Jun 28, 2020 3:32 pm

alex_686 wrote:
Sun Jun 28, 2020 12:06 pm
1. Because BNDW is small.

2. Yes, during the market crisis the NAVs where kicking out garbage results. ETF prices where correct. BNDW’s prices where built off the other 2 ETF prices, So that is why the were in line.

3. Don’t know. However, it will remain open as long as its is popular. The size of the 2 underlying funds do not matter.

4. No tac concerns here. Mutual funds are pass through structures.
Thanks! However I don’t understand answer #2. BND and BNDX individually have had significant discounts to NAV. But BNDW doesn’t appear to have been affected as much. How could this be?

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vineviz
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Re: Understanding the “ETF of ETFs” structure

Post by vineviz » Sun Jun 28, 2020 3:56 pm

BogleBuddy12 wrote:
Sun Jun 28, 2020 3:32 pm
alex_686 wrote:
Sun Jun 28, 2020 12:06 pm
1. Because BNDW is small.

2. Yes, during the market crisis the NAVs where kicking out garbage results. ETF prices where correct. BNDW’s prices where built off the other 2 ETF prices, So that is why the were in line.

3. Don’t know. However, it will remain open as long as its is popular. The size of the 2 underlying funds do not matter.

4. No tac concerns here. Mutual funds are pass through structures.
Thanks! However I don’t understand answer #2. BND and BNDX individually have had significant discounts to NAV. But BNDW doesn’t appear to have been affected as much. How could this be?
BND and BNDX each own individual bonds, and the market price of those bonds determined the NAVs of those funds. When the bond prices went stale, so did the NAVs.

BNDW doesn’t own individual bonds, so its NAV never went stale.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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J G Bankerton
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Re: Understanding the “ETF of ETFs” structure

Post by J G Bankerton » Sun Jun 28, 2020 4:28 pm

BogleBuddy12 wrote:
Sun Jun 28, 2020 11:26 am
4. Are there any differences to note when it comes to taxes and dividends? Does the ETF of ETFs duplicate the tax efficiency of the two underlying ETFs?
Vanguard has your back on taxes.
How Vanguard Patented a System to Avoid Taxes in Mutual Funds

alex_686
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Re: Understanding the “ETF of ETFs” structure

Post by alex_686 » Sun Jun 28, 2020 8:49 pm

J G Bankerton wrote:
Sun Jun 28, 2020 4:28 pm
BogleBuddy12 wrote:
Sun Jun 28, 2020 11:26 am
4. Are there any differences to note when it comes to taxes and dividends? Does the ETF of ETFs duplicate the tax efficiency of the two underlying ETFs?
Vanguard has your back on taxes.
How Vanguard Patented a System to Avoid Taxes in Mutual Funds
Former mutual fund accountant here. Your link has nothing to do with the OP’s question. It is the FoF structure that avoids the taxes. Mutual fund or ETF. Vanguard or somebody else. None of these would pay double taxation.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.

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J G Bankerton
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Re: Understanding the “ETF of ETFs” structure

Post by J G Bankerton » Mon Jun 29, 2020 11:00 am

alex_686 wrote:
Sun Jun 28, 2020 8:49 pm
J G Bankerton wrote:
Sun Jun 28, 2020 4:28 pm
BogleBuddy12 wrote:
Sun Jun 28, 2020 11:26 am
4. Are there any differences to note when it comes to taxes and dividends? Does the ETF of ETFs duplicate the tax efficiency of the two underlying ETFs?
Vanguard has your back on taxes.
How Vanguard Patented a System to Avoid Taxes in Mutual Funds
Former mutual fund accountant here. Your link has nothing to do with the OP’s question. It is the FoF structure that avoids the taxes. Mutual fund or ETF. Vanguard or somebody else. None of these would pay double taxation.
I was just commenting on how Vanguard's ETF are just a different class of shars in the mutual fund. Vanguard has a patent on combining the two.

I just found that link about how Vanguard saves us taxes. This link explains Vanguards patent, US6879964B2, it does more than just save taxes. It is some heavy reading.

Investment company that issues a class of conventional shares and a class of exchange-traded shares in the same fund

Image

alex_686
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Re: Understanding the “ETF of ETFs” structure

Post by alex_686 » Mon Jun 29, 2020 11:17 am

J G Bankerton wrote:
Mon Jun 29, 2020 11:00 am
I was just commenting on how Vanguard's ETF are just a different class of shars in the mutual fund. Vanguard has a patent on combining the two.
What you are posting is true. And the sky is blue. It is just it is irrelevant to the OPs question. What is relevant is that it is a fund, and funds are pass through structures.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.

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J G Bankerton
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Re: Understanding the “ETF of ETFs” structure

Post by J G Bankerton » Mon Jun 29, 2020 11:34 am

alex_686 wrote:
Mon Jun 29, 2020 11:17 am
J G Bankerton wrote:
Mon Jun 29, 2020 11:00 am
I was just commenting on how Vanguard's ETF are just a different class of shars in the mutual fund. Vanguard has a patent on combining the two.
What you are posting is true. And the sky is blue. It is just it is irrelevant to the OPs question. What is relevant is that it is a fund, and funds are pass through structures.
I'm just pointing out that ETFs and mutual funds are really the same under the hood. The only difference is ETFs have Authorized Participant, arborators, who keep the ETF's value the same as the NAF of the securities it holds.

I wonder about these Authorized Participants, they take value from the ETF yet the ETFs value stays very close the NAV of the securities it holds.

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Re: Understanding the “ETF of ETFs” structure

Post by alex_686 » Mon Jun 29, 2020 12:16 pm

Having worked with prices in this area, your comment is a bit off:
J G Bankerton wrote:
Mon Jun 29, 2020 11:34 am
The only difference is ETFs have Authorized Participant, arborators, who keep the ETF's value the same as the NAF of the securities it holds.

I wonder about these , they take value from the ETF yet the ETFs value stays very close the NAV of the securities it holds.
It assumes that NAV is a good correct value. If the AP were skimming from the trades that skimming would reduce the NAV. You can't detect it this way.

Figuring out how the arbitrages are making their money and if it is from you is hard. From the outside it is even harder. The best choice would probably look at the tracking error to find the total drag from the fund. Expenses, trading with the AP, etc.

That being said, I don't think this is a issue. APs swap one basket of securities for another. If we are looking at a "Apple" ETF, the APs would be swapping 1 share of Apple for 1 share of the "Apple" ETF no matter what the price. There is just nothing there from them to exploit. All of the trading, risk and arbitrage profits and on the other side - between the AP and the market.
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senex
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Re: Understanding the “ETF of ETFs” structure

Post by senex » Mon Jun 29, 2020 1:08 pm

J G Bankerton wrote:
Mon Jun 29, 2020 11:34 am
I wonder about these Authorized Participants, they take value from the ETF yet the ETFs value stays very close the NAV of the securities it holds.
As Alex said, the APs don't make money from the fund or its shareholders. With some rare exceptions, each create/redeem is economically neutral.

The APs make money by pushing the etf price toward nav. It diverges from nav due to non-APs being inefficient or lazy. Pushing it to nav is a source of profit.

Whenever you wanted to hold etf XYZ, if instead of blindly buying XYZ, you evaluated every possible way of achieving equivalent exposure [*], and did the cheapest of those things, and if every market participant did that analysis for every etf trade, then APs would have nothing to do and would make no profit. Everything would stay at nav. The profit of the AP is from you (and many people) saying: I can't analyze every linear combination of 6000 stocks, just make it easy, sell me some XYZ, and *you* figure out the cheapest way to obtain that exposure. Due to competition between APs, it is usually cheap, and worth it.

[*] you could buy every one its constituents, or you could buy any weighted linear combination of stocks and etfs that yields equivalent exposure to its constituents.

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J G Bankerton
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Re: Understanding the “ETF of ETFs” structure

Post by J G Bankerton » Mon Jun 29, 2020 3:54 pm

senex wrote:
Mon Jun 29, 2020 1:08 pm
J G Bankerton wrote:
Mon Jun 29, 2020 11:34 am
I wonder about these Authorized Participants, they take value from the ETF yet the ETFs value stays very close the NAV of the securities it holds.
The APs make money by pushing the etf price toward nav. It diverges from nav due to non-APs being inefficient or lazy. Pushing it to nav is a source of profit.
[*] you could buy every one its constituents, or you could buy any weighted linear combination of stocks and etfs that yields equivalent exposure to its constituents.
I could buy the mutual fund class of the ETF and always get NAV at the close. I used to do that until the ETFs became one bases point less expensive.

I know Vanguard posts if the ETF is selling at a discount or a premium but that is always a day behind because they don't know the NAV until the close. Fortunately the discount or premium is small, especially if one is only buying a few shares at a time.

For 2019 VOO sold at a discount 50.8%% of the time; I like to buy the dips so I should have a better than even chance of buying at a discount.

With the fund having $519.2 billion AUM it only takes a basis point or two to keep the arborators happy and coming back for more.

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Re: Understanding the “ETF of ETFs” structure

Post by alex_686 » Mon Jun 29, 2020 4:19 pm

I think you are implying and assuming things you should not.
J G Bankerton wrote:
Mon Jun 29, 2020 3:54 pm
I could buy the mutual fund class of the ETF and always get NAV at the close. I used to do that until the ETFs became one bases point less expensive.
Let me emphasis that you get the NAV price, with is just a accountant's estimate. Or you can go to the exchange and get the market price. Both NAV and market prices are high quality indicators. However, in my experience, the market price is the higher quality data point.
J G Bankerton wrote:
Mon Jun 29, 2020 3:54 pm
I know Vanguard posts if the ETF is selling at a discount or a premium but that is always a day behind because they don't know the NAV until the close. Fortunately the discount or premium is small, especially if one is only buying a few shares at a time.
Vanguard publishes the ETF NAV every 15 minutes. It helps if you have access to a premium price service.
J G Bankerton wrote:
Mon Jun 29, 2020 3:54 pm
For 2019 VOO sold at a discount 50.8%% of the time; I like to buy the dips so I should have a better than even chance of buying at a discount.
No, not really. This is more of a statistical oddity. Prices can skew slightly at close due to order imbalances. We are talking coin toss here.
J G Bankerton wrote:
Mon Jun 29, 2020 3:54 pm
With the fund having $519.2 billion AUM it only takes a basis point or two to keep the arborators happy and coming back for more.
But how? It is not coming from the expense ratio - that specifically excludes trading costs. The AP has no access to assets. It has to come from the market's order flow and even that is indirect. What they do have access is the redemption/creation process and how that process interacts with the order flow. So you would want to start off on the volume of share redemption & creation.
Last edited by alex_686 on Mon Jun 29, 2020 4:53 pm, edited 1 time in total.
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Re: Understanding the “ETF of ETFs” structure

Post by ChrisBenn » Mon Jun 29, 2020 4:40 pm

J G Bankerton wrote:
Mon Jun 29, 2020 3:54 pm
.

I know Vanguard posts if the ETF is selling at a discount or a premium but that is always a day behind because they don't know the NAV until the close. Fortunately the discount or premium is small, especially if one is only buying a few shares at a time.
https://finance.yahoo.com/quote/%5EVOO-IV/

As alex_686 mentioned, published live every 15 minutes. (on yahoo it's normally "^ETFNAME-IV")

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Re: Understanding the “ETF of ETFs” structure

Post by J G Bankerton » Mon Jun 29, 2020 4:54 pm

alex_686 wrote:
Mon Jun 29, 2020 4:19 pm
Vanguard publishes the ETF NAV every 15 minutes. It helps if you have access to a premium price service.
The AP has no access to assets.
I should have said market price, the market price is the NAV of the mutual fund at the close. That is what the premium or discount of the ETF is compared to.

‭The AP does have access to the assets in creation units. When the ETF is trading at a discount they buy creation units low and sell them at market value.


"Authorized participants will reduce ETF shares in circulation when the price of the ETF is lower than the price of the underlying shares. That can be done with the creation and redemption mechanism that keeps the price of an ETF aligned with its underlying net asset value (NAV)."

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Re: Understanding the “ETF of ETFs” structure

Post by grabiner » Mon Jun 29, 2020 10:21 pm

ChrisBenn wrote:
Mon Jun 29, 2020 4:40 pm
J G Bankerton wrote:
Mon Jun 29, 2020 3:54 pm
.

I know Vanguard posts if the ETF is selling at a discount or a premium but that is always a day behind because they don't know the NAV until the close. Fortunately the discount or premium is small, especially if one is only buying a few shares at a time.
https://finance.yahoo.com/quote/%5EVOO-IV/

As alex_686 mentioned, published live every 15 minutes. (on yahoo it's normally "^ETFNAME-IV")
Note that this number is not reliable for ETFs whose holdings trade in closed markets, such as BNDX. There isn't a current value for Japanese stocks or Australian bonds during the US trading day. (The trading price provides a better indication; if a Japanese stock ETF drops by 1%, this implies that investors expect the Japanese market to open 1% lower than their previous estimate.)
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