What is Premium to Net Asset Value (NAV) and How Does it Work?

What Is Premium to Net Asset Value?

Premium to net asset value (NAV) occurs when the market price of an exchange-traded investment fund is higher than its daily reported accounting NAV. This situation typically affects closed-end mutual funds and exchange-traded funds (ETFs) and is driven by investor optimism about the underlying assets or the fund's management strategy.

Identifying funds trading at a premium or discount to their NAV requires considerable market information. Find out how premium to net asset value affects your investments, and what it signals about market sentiment.

How Premium to Net Asset Value Impacts Fund Pricing

Closed-end mutual funds and ETFs calculate a NAV at the end of each trading day. The NAV represents the price of all of the fund’s assets minus the fund’s liabilities divided by the number of shares outstanding. Funds typically also report an intra-day NAV.

Since a fund’s NAV only represents the total value of the assets in the fund at the end of the day, there is significant latitude for funds trading on exchanges to fluctuate from their NAV.

In the case of a premium to NAV, the fund will be trading above its representative NAV. A premium to NAV can be caused by numerous market factors. Throughout the day the securities in the fund may report news or financial information that positively influences its price.

A particular sector may also be reporting a positive trend that can affect funds managing assets in that sector. Premiums may also rise from optimistic sentiment toward a fund company, investment strategy, or individual fund management team.

Investing in Funds at a Premium to NAV

A premium to NAV is most often driven by a bullish outlook on the securities in a fund. Investors are generally willing to pay a premium because they believe securities in the portfolio will end the day higher. Retail investors often do not have extensive data on all of the underlying holdings of a fund.

Highly diversified funds may also cause a disconnect between the NAV and market value price, providing greater flexibility for the market price to trade at a premium. Overall, the reporting of the intra-day NAV can be highly influential in determining the fund’s price divergence and its cumulative premium to NAV calculations.

Open-end exchange-traded investment funds have a greater ability to manage the deviations of a fund from its NAV. ETFs, in particular, have authorized participants who actively monitor the price of an ETF in comparison to its NAV. Authorized participants have the authority to create or redeem shares of open-end ETFs in order to manage the product’s price volatility.