By Dina Ting, head of global index portfolio management at Franklin Templeton
Last month offered investors another reminder of how quickly the outlook for an overseas market can change while its local exchange is closed. Developments affecting two of Asia’s largest equity markets included renewed US-China tariff uncertainty and an unexpected shift in US-South Korea military exercises.
So what is the value of an exchange-traded fund (ETF) that accesses overseas markets when those markets can’t react to news at the same time? This timing gap raises an important question that comes up periodically in client conversations: When an overseas market is closed, what’s an international ETF worth?
An international ETF may continue trading on its listing exchange after the markets for its underlying securities have closed. A South Korea or China equity ETF trading in New York or Europe, for example, can respond to trade policy, geopolitics, economic data or moves in global markets even though many of its holdings are no longer trading. This helps explain why a fund’s market price can diverge from its reported net asset value (NAV) and where fair value pricing enters the picture.
Two prices, two clocks
An ETF essentially has two measures of value. Its market price is what investors are willing to pay for its shares on an exchange, changing throughout the trading day. Its NAV represents the calculated value of the securities the fund owns. For an international ETF, many of those securities may have stopped trading hours earlier.
Suppose Korean stocks close 3% higher. Several hours later, while an ETF tracking Korean equities is still trading, fresh news causes global equities to fall sharply. Korean stocks cannot react because their local market is closed. But the ETF can.
Market makers and other investors can incorporate the new information into the price they are willing to pay. The ETF’s market price may fall even though a NAV based on Korean closing prices still reflects the earlier gain. This can make the ETF appear to trade at a significant “discount” to NAV. But that doesn’t necessarily mean the ETF is mispriced. It may instead reflect what an exchange-traded security is designed to provide: real-time price discovery.
Fair value pricing
Many international funds address this timing mismatch through fair value (FV) pricing. Rather than simply using closing prices, an FV methodology estimates how securities might have traded had their home market remained open. A local closing price from hours earlier may no longer reflect everything markets now know.
But “fair value” should not be confused with a uniquely correct value. The local closing price is observable; FV is a model-derived estimate, with no single industry standard. Different methodologies can use different inputs and produce different answers.
Proprietary FV models may also not be fully transparent or independently replicable by the authorized participants (APs) and market makers that facilitate ETF trading. These participants place considerable value on knowing how an ETF’s NAV will be determined. If they cannot replicate a valuation methodology, they face another variable to estimate, and that uncertainty can translate into higher trading costs. A more current estimate is not necessarily a more transparent price.
FV pricing can also complicate assessment of how effectively an index portfolio tracks its benchmark. If the index uses local closing prices while the ETF’s NAV reflects FV adjustments, some tracking difference may reflect different valuation methodologies rather than portfolio management. A consistent approach can provide a clearer view of tracking. That’s another reason we do not believe international ETFs necessarily need to be systematically fair valued every day.
There is also a practical issue in markets such as India and South Korea, where securities needed for certain ETF transactions cannot simply be exchanged directly between the fund and an AP. Instead, the AP provides cash and the underlying securities are traded when the local market is open.
If a model estimates that Korean stocks have moved substantially after Seoul closes, that estimate is not necessarily a price at which those securities can be traded. When the market reopens, execution takes place at available market prices, with the trading borne by the AP rather than passed on to the fund.
This is why we view FV as a tool rather than an automatic daily overlay. It can play an important role when observable prices are unavailable or unreliable, such as during trading halts or significant market disruptions. Under normal conditions, observable prices provide a consistent basis for valuation, while the ETF’s market price continues incorporating new information.
For investors comparing international ETFs, the valuation process is therefore worth understanding. Is the NAV methodology transparent and replicable? Can APs and market makers anticipate how a fund will be valued? And is FV used when observable prices genuinely become unreliable, or systematically applied as another modelling layer?
Global markets never operate on one clock. While one market sleeps, another is digesting the latest economic, policy or geopolitical development. In our view, the goal should not be to make every valuation measure look identical at every moment. It should be to maintain a disciplined, predictable valuation process while allowing the ETF structure to continue providing price discovery even when the underlying market has stopped trading for the day.
