1. Why was NAV-based trading developed?
The benchmark index ETFs that have dominated and continue to dominate the ETF market were originally developed to provide something to trade on the Toronto Stock Exchange in Canada and the American Stock Exchanage in the United States. These ETFs were based on popular benchmark indexes that had a variety of traded instruments (such as futures and options) available for use in hedging the trading of shares in the ETFs and for a variety of other purposes. The original mantra for the SPDR was "trades just like a stock". The creators of the original ETFs developed a better fund structure than the existing mutual fund structure but intraday trading and fully transparent portfolios do not meet the needs of most serious investors.
Intraday trading is not necessary if a mechanism exists to assure that the shares of an ETF trade at a close relationship to the fund's daily net asset value. NAV-based trading was developed to provide such a mechanism. Most of the trading that occurs in the most popular benchmark index ETFs is done for risk management applications by securities industry professionals. These professionals will also use NAV-based trading, but its principal purpose is to provide a trading mechanism that permits a wide range of investors and their advisors to trade at a prices with a known relationship to the net asset value of the underlying portfolio. NAV-based trading is also essential for ETFs that do not have totally transparent portfolios to trade at a price close to their net asset value without compromising the integrity of the fund's invesstment process.
See The Exchange-Traded Funds Manual, 2nd Edition, Chapter 8 and How to Minimize Your Cost of Trading.
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