ETFs As Price Discovery Mechanisms

A reader asks;

How can the Egypt Vectors ETF (EGPT), down 5% just today, continue to trade when the Egyptian stock exchange has been closed during the unrest and is not scheduled to open until Sunday?

Coincidentally I was asked for an opinion about this fund for a news story that should be out shortly if it is not out already. First things first is that there are a lot of moving parts to this situation. If you care about the particulars of this ETF's mechanics then you should read this post by Dave Nadig who has done the requisite sleuthing. The short story is that there have been no creations for the fund in weeks, there is a bunch of cash in the fund and it is trading at a premium to its IIV. Read Dave's post for the potential implications here.

There is a bigger picture component to the question that should be generally relevant for certain types of future market disruptions.

There are several reasons why EGPT can trade despite the issues that currently exist. First, but in no particular order, several of the fund's larger components trade in London or Canada so they have been trading on their respective markets just fine ("just fine" meaning market mechanics not a qualitative comment on their prospects).

The next point is that the very existence of the fund makes it a vehicle for price discovery. Forgetting for a moment the premium to IIV and the cash built up, the shares are bought and sold based on perception of fair market value just like any other traded thing. The shares of the ETF could not reasonably be suspended as preventing someone from getting out would be very bad for that person along with the fund provider's reputation and a wouldbe seller needs a buyer on the other side of his trade. Now factoring in the premium and cash which each complicate the matter but does not change the fact that in lieu of anything else, the fund helps with price discovery.

The final point is that many of these funds trade everyday when the home market is closed. There is no overlap in a trading day between the US and Asian/Antipodean markets yet the funds function as access and price discovery every day. The current state of the Egyptian market makes EGPT's role in price discovery more important than normal but it is not as different as it might seem.

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ETFs As Price Discovery Mechanisms

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