Russian ETF prices deviate sharply from the underlying value

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Premiums for exchange-traded funds focused on overseas-listed Russian securities have risen to unprecedented levels even as other Russia-focused ETFs plunge into historic discounts amid disjointed trading.

The $446 million VanEck Vectors Russia ETF (RSX) closed Tuesday at $8.26, a 177% premium to its net asset value of $2.98 per share.

Similarly, the iShares MSCI Russia ADR/GDR Ucits (CSRU) ETF closed at $28, 59.7% above its net asset value of $17.53.

However, most Russia-focused ETFs plunged into deep discounts, with the $165m iShares MSCI Russia ETF (ERUS) and iShares MSCI Eastern Europe Capped UCITS ETF (IEER) both closing at $165m discounts. 50 to 60% relative to the net asset value.

ETFs generally trade at prices very close to their net asset value, because the creation and redemption process used to determine the number of shares issued produces an arbitrage mechanism that allows market makers to take advantage of any variations.

However, due to the sanctions imposed on many Russian companies after the invasion of Ukraine, the closure of the Moscow Stock Exchange, capital controls and the reluctance of some ETF issuers to increase their exposure to securities many Russian-focused ETFs have halted the creation process and sometimes also the redemption process, causing the arbitrage mechanism to break.

ETFs that invest largely or entirely in Russia-focused U.S. and global certificates of deposit — securities listed in the U.S. or Europe that represent ownership of the company’s underlying stocks — such as RSX and CSRU have swung to large bounties.

With the Moscow Stock Exchange remaining closed since Friday, these ADRs and GDRs have become the main means of discovery of Russian stock prices. ETF premiums suggest that at least some market participants believe these certificates of deposit have been pushed to unrealistic levels in the rush to exit.

While these investors might simply buy ADRs and GDRs, they are increasingly difficult to trade and ETFs can offer greater liquidity.

With many certificates of deposit now trading at pennies, some investors are clearly willing to take the risk to buy, said Dan Izzo, managing director at ETF market maker GHCO.

Line chart of Premium/Discount to Net Asset Value (%) showing iShares MSCI Russia ETF (ERUS)

“An ad can [potentially] risk overturning everything and [the market] comes back, no matter how unlikely it seems,” he said. “Whatever the RSX price is going to be where the collective market will value it.”

Todd Rosenbluth, head of ETF and mutual fund research at CFRA Research, said that with the suspension of new unit creation in ETFs such as ERUS, while market makers can still redeem existing units, “there is an imbalance between supply and demand that has occurred due to the lack of creation” that produced the premiums to NAV.

The contrast with ETFs investing directly in Russian stocks listed in Moscow is stark.

“These ETFs have continued to trade but the net asset value is out of date as it is based on prices from a few days ago, before the negative impact of the sanctions was fully appreciated by the market,” Rosenbluth said, hence the fall of these ETFs towards deep discounts on these obsolete ones. NAV.

BlackRock warned investors that ERUS “may fail to achieve its investment objective, may experience increased tracking error, may experience significant premiums or discounts to its net asset value and/or have bid-ask spreads wider than its historical average”.

Izzo thought traders who were playing RSX and CSRU in hopes of a rally in the underlying stocks were playing with fire.

“There is a very real risk and expectation that GDRs will be delisted as all instruments in Europe linked to Russia are being phased out of the market,” he said.

“Anyone who is long risks trapping capital in this product. Your capital could be locked in dead weight for 20 years.

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