Question

(Chapter 4) You are an individual investor who is bullish on the finance sector of the US equity market. Rather than purchase shares of stock of several individual firms in the sector, you decide to reduce trading costs by purchasing XLF, a US finance sector equity ETF. How can you be confident that the price of the XLF will closely track the net asset value (NAV) of the underlying shares of stock in the benchmark index?

Answer 1

Net asset value (NAV) represents a fund’s per unit market value. This is the price at which investors buy fund units from a fund company or sell it back to the fund house. It is calculated by dividing the total value of all the assets in a portfolio, minus all its liabilities. The NAV of a fund is calculated by the mutual fund house itself or by an accounting firm hired by the mutual fund.

When the amount of investment in different schemes is the same, the NAV's are irrelevant. What an investor needs to closely look at are the returns given by the scheme.

ETF, one of the powerhouse SPDR products, provides exposure to an index that includes companies from the following industries: diversified financial services; insurance; commercial banks; capital markets; real estate investment trusts; thrift & mortgage finance; consumer finance; and real estate management & development. XLF contains the who's-who of the financial players in the domestic economy, including JP Morgan, Wells Fargo, and others. This makes it an ideal play on the U.S. financials world, which has not always been stable. After the 2008 U.S. recession, many of the financial companies in the U.S. came under a great deal of scrutiny for irresponsible practices that lead to the downfall of the economy. Since then, the government has not been shy about imposing new regulations and legislation on these big name banks and institutions. Investors looking into this product show be aware that it will likely be very effected by U.S. policy as we aim to ensure that another crisis of this magnitude does not repeat itself. Investors should also note that XLF pays out a decent dividend, which may provide steady income in times of market downturns.