ETFs With the Biggest Premiums, Discounts

Efficient pricing is high on the list of selling points for exchange-traded funds.

Unlike closed-end funds, which are also bought and sold on an exchange but can trade at big discounts or premiums to their net asset values, ETF share prices tend to closely track the value of their holdings.

That's because they benefit from a complicated arbitrage mechanism: Institutional traders can assemble large baskets of the underlying stocks, exchange them for ETF shares and sell at a profit. If an ETF is trading at a discount to its NAV, arbitragers can buy the fund's units in bulk, exchange them for the underlying securities and then sell these securities at a profit.

For example, for the 13-week period ended Oct. 27, 2006, the absolute difference between the market price and the NAV of the average closed-end fund tracked by TheStreet.com Ratings was 6.97%. That was 77 times wider than the absolute difference for the average ETF, which came out to a microscopic 0.09%.

[Absolute values were used in calculating averages in order to focus on the magnitude of difference between market prices and NAVs, rather than the direction of the dispersion. For example, a simple average of a fund with a premium of 50% and one with a discount of 50% would be zero. But using absolute values would result in an average of 50% -- indicating an extremely high tendency to experience premiums and discounts.]

But although the average ETF has been selling within a whisper of its NAV, some have been averaging premiums and discounts nearly 10 times higher. The accompanying list includes those with average premiums or discounts greater in magnitude than plus or minus 0.5% for the 13-week span ending Oct. 27.

This matters because investors can get burned if they buy an ETF at a premium to its net asset value and sell at a discount.

The list is dominated by ETFs that invest in non-U.S. stocks, many of which have relatively small floats, or shares outstanding and available for public trading. This can make it difficult to obtain the stock needed to create or redeem fund shares when trading volume picks up.

ETFs With Biggest Average Premiums, Discounts Even the outliers trade closer to NAV than most closed-end funds
Fund Name & Ticker	Investment Objective	Inception Date	13-Week Avg. Premium/ Discount*	Total Net Assets ($Mil)	TSC Rating #
WisdomTree Intl Large Cap Dividend (DOL)	Non-U.S. Equity	6/16/06	0.83	NA	U
WisdomTree Intl Small Cap Dividend (DLS)	Non-U.S. Equity	6/16/06	0.79	NA	U
WisdomTree Intl Dividend Top 100 (DOO)	Non-U.S. Equity	6/16/06	0.75	NA	U
WisdomTree Europe Small Cap Div (DFE)	Non-U.S. Equity	6/16/06	0.75	NA	U
WisdomTree Intl Mid Cap Div (DIM)	Non-U.S. Equity	6/16/06	0.67	NA	U
WisdomTree DIEFA High Yielding Eq (DTH)	Non-U.S. Equity	6/16/06	0.64	NA	U
WisdomTree Europe High Yielding Eq (DEW)	Non-US Equity	6/16/06	0.64	NA	U
WisdomTree DIEFA (DWM)	Non-U.S. Equity	6/16/06	0.61	NA	U
iShares MSCI EAFE Value (EFV)	Non-U.S. Equity	8/1/05	0.55	353.11	A+
Vanguard European ETF (VGK)	Non-US Equity	3/10/05	0.55	508.32	A+
PowerShares Dynamic Oil & Gas Svc (PXJ)	Sector - Energy/Natural Res	10/26/05	0.54	336.13	U
iShares MSCI EAFE Growth (EFG)	Non-U.S. Equity	8/1/05	0.51	246.86	B+
Rydex S&P Small Cap 600 Pure Gr (RZG)	Growth - Domestic	3/1/06	0.51	8.17	U
iShares MSCI Malaysia (EWM)	Non-U.S. Equity	3/12/96	-0.63	394.96	C-
iShares MSCI Taiwan (EWT)	Non-U.S. Equity	6/20/00	-0.71	2,050.41	E+
Average of above funds **			0.65	556.85
Average for all ETFs **			0.09	1,409.19
Average for traditional closed-end funds			6.97
* - As percent of net asset value per share. ** - Absolute values (negative values converted to positive numbers) used for averages of premiums/discounts at bottom of table. # - "U" = unrated. Premium/discount Averages are for the 13 weeks ended Oct. 27, 2006.

Also, shares of ETFs that invest abroad are traded primarily during U.S. trading hours. If the underlying shares can only be bought or sold on a foreign market in a different time zone, it could be more difficult to keep the fund's price in close line with its net asset value.

It's also worth noting that the majority of the ETFs on the list are only a few months old. Investor enthusiasm for a new fund could conceivably bid the shares up to a premium even if arbitrageurs are buying baskets of the underlying stock to exchange for new shares.

The youngest ETFs listed in the table are from WisdomTree, a new market entrant. The firm has been a vocal proponent of weighting market indices by the dividends of the component stocks, as opposed to the more common practice of using market-value weightings. Wisdom Tree's principals have conducted back-testing of their indices indicating that using this methodology tends to produce superior returns than traditional indices accompanied by lower portfolio volatility.