When ETF shares appear to be trading at a discount to the index of stocks they hold, according to a recent article in The Wall Street Journal by columnist Jason Zweig, “the apparent bargain is an illusion.”
“Stock indexes, and by extension the funds that are based on them, are averages,” writes Zweig, adding, “Investment regulators say that fund companies are free to calculate and report an average valuation any way they wish, so long as it doesn’t mislead or deceive investors. So you should pay attention to how these funds report valuations.”
Zweig cites examples of firms and the varying approaches they use to calculate average valuations. One such firm, State Street Global Advisors, he reports, “ignores money-losing companies when it calculates average valuation, ” and that other firms also leave out extremely profitable companies or those suffering extreme losses so as not to distort the P/E of an index.
According to Dorothy Lariviere, a product consultant at iShares, “using different methodologies may be introducing a level of noise,” the article says. She adds, “Having more standardization would be helpful to investors evaluating ETF portfolios tracking the same benchmark.”
Zweig concludes, “Until that happens, don’t let yourself imagine that one ETF is ‘cheaper’ than another that follows the same index—or that either is cheaper than the index itself.”