A disconnect has emerged in Nigeria’s equity market, where Exchange Traded Funds (ETFs) are posting triple-digit returns that bear little resemblance to the underlying assets they track, raising alarms for retail investors about a looming correction.
The most prominent example is the Stanbic IBTC ETF 30 (STANBICETF30). While the NGX 30 Index has gained a modest 12.62% year-to-date, the ETF tracking it has surged approximately 497%. The fund, which opened the year at N1,066 per share, was trading at N6,367.24 by Tuesday, according to data from Investing.com.
Equally, this can be seen with the Vetiva Consumer Goods ETF (VETGOODS), which has gained 148 per cent year-to-date, compared to the NGX-Consumer Goods, which has only gained 5.19 per cent. VetivaBank ETF, which tracks the NGX-bank index, has rallied 164 percent this year compared to the bank index, which has only returned 12.79 percent in the same period. Similarly, Greenwich Alpha, an open-ended ETF tracking the NGX 30, has returned 160.3 percent, surpassing the index’s performance of 12.62.
“The reason for the divergence is that the ETFs are thinly traded, and there is no price discovery. And this means that the prices will eventually correct at some point,” Abdulrauf Bello, a portfolio manager at Cowrywise, said.
“Eventually, the market will realise the ETF isn’t worth that much. When people stop overpaying, the price will return to its real value.”
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What is an ETF?
An exchange-traded fund (ETF) is an investment fund that holds multiple underlying assets. It can be bought and sold on an exchange, much like an individual stock. ETFs can be structured to track anything from the price of a commodity to a large and diverse collection of stocks, even specific investment strategies.
What are the advantages of an ETF?
Generally, the core advantages of ETFs are: exposure to many stocks or a sector with just one trade, dilution of concentration risk, cost efficiency, and not paying performance fees for stock recommendations.
It also offers accessibility, generally for small investors whose psychology tends to react when they see stocks that are expensive on a per-share basis.
How does an ETF tracking the NGX 30 work?
For instance, an ETF called XYZ 30 is meant to track the NGX 30, the top 30 most liquid and solid stocks on the NGX. It must invest 100 percent of its assets in the same portfolio of securities as the NGX 30 in proportion to their weights. The main objective is to replicate both the price return and total return of the index.
Why are ETF-30 prices and returns higher than the NGX 30 currently?
The ETF’s trading price can move significantly away from the combined value of the underlying assets, because it is subject to demand and supply like a stock.
If the ETF is detached from its Net Asset Value (NAV), the only way you realise gains is if someone else is willing to pay that inflated price when you sell.
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How would these ETFs correct?
The two ETFs that track the NGX 30 have gained way more than the underlying assets they track. That is an anomaly.
“I think the price gain you see in ETFs is speculative at best or a result of the structural inefficiency. This price deviation is not guaranteed to persist, and it can drop sharply,” Bello said.
What are some of the structural limitations causing the spread?
ETFs can only successfully track their indexes when there is tight price to NAV tracking, there are active market makers, and functional arbitrage.
“It’s the lack of arbitrage. Typically, ETFs have institutional players that correct mispricing. If the ETF is trading at a premium, they buy the underlying stocks and exchange them for shares of the ETF, which they can now sell in the open market to correct the price,” Adedayo Bakare, COO of MoneyAfrica said.
When these are missing, ETFs lose their advantage, and they behave like illiquid single stocks.
Bello said that the ETFs we have for now are somewhat broken, and they somewhat already defeat the purpose.
What should investors do?
Bello said that investors who must buy ETFs today should note the price they are buying it. “Note the value of the underlying asset the ETF tracks. The person who sells today gets his gain from you. Maybe tomorrow, you can sell to another person who buys at an inflated price,” he said.
