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Discounted ETFs Are Not Necessarily Bargains

NEW YORK ( TheStreet) -- After Chairman Ben Bernanke talked about tapering the Federal Reserve's stimulus program, stocks and bonds cratered on June 20. With investors racing to sell, many ETFs traded at discounts to the value of the assets in their portfolios.

Emerging markets funds took particularly hard hits, with some selling at discounts of more than 6%. Some municipal funds posted discounts of more than 2%. Since then, prices have recovered, but many ETFs still trade at discounts. Funds that trade at discounts of more than 1% include iShares MSCI Emerging Markets (EEME) and SPDR Nuveen S&P High Yield Municipal (HYMB).

For some investors, the discounts look tempting. After all, bargain hunters love to buy a dollar worth of assets for 99 cents. But analysts sound a note of caution. "When an ETF trades at a discount, it is not necessarily a buying opportunity," says Timothy Strauts, a senior fund analyst for Morningstar.

ETFs can slip to discounts for different reasons. To appreciate why emerging markets funds dipped last month, consider a hypothetical ETF that has $100,000 in emerging markets stocks and 10,000 shares. When markets in Asia and Africa closed on the day before the big downturn, each share in the ETF traded for $10 and was backed by that amount of assets. The fund did not trade at a discount. With the Asian stock exchanges shut for the day, share prices in much of the emerging markets could not change for 16 hours.

Meanwhile, markets opened in the U.S. After the Fed's unsettling news, investors worried that any trouble in the U.S. would also hurt emerging markets. Traders dumped shares of the hypothetical emerging markets ETF. While the ETF share price fell, the prices of many of the stocks in the portfolio could not budge because the Asian markets were shut. The ETF share price fell to $9 even though the value of the stocks in the fund remained at $10. As a result, the fund sold at a double-digit discount.

Despite the big discount, analysts say that the ETF is not really a bargain. When trading resumes overseas, the stocks are likely to fall down to the level of the ETF shares, and the discount will narrow. So investors who buy at discounts are not likely to book any windfall gains. "If you hold ETFs for long time horizons, it is irrelevant to you whether or not the securities swing to temporary discounts," says Paul Baiocchi, an analyst for IndexUniverse.com.
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