As has been widely covered, the Greek stock market is finally back open for business, and the non-news is that the Global X FTSE Greece 20 ETF (GREK | C-61) did exactly what it was supposed to do.
Monday saw Greece’s stocks close its first day of trading in more than a month down about 16 percent, which sounds horrible and catastrophic. But it’s worth walking through the steps Global X took in order to make sure ETF investors had as few surprises as possible.
Let’s start with the basics. Here’s the value of the actual index GREK tracks, the FTSE/ATHEX 20, versus the closing price and net asset values for GREK over the past quarter:
That flat line for the index starts on June 29, the day the Greek markets closed. So how is it that GREK, which previously looked like it was tracking its index pretty darn well, wasn’t flat?
Immediately after the markets closed in Athens, Global X issued a new prospectus update changing how they were going to deal with the market disruption. Here’s a quote.
“During the closure of the Athens Exchange, the Fund will fair value its security holdings for which current market valuations are not currently available using fair value pricing pursuant to the pricing policy and procedures approved by the Fund’s Board of Trustees.”
Like we discussed when looking at the China A-share market, “fair value” here is code for “guess.” And this is generally the appropriate reaction from an issuer when things get hairy. Rather than just leave the value of the fund static for who knows how long, they fired up the fancy math at the fund accountant, deriving their best guesses each day for what the securities in the fund were actually worth (based on derivatives, trading American depositary receipts, etc).
Right out of the gate, both the trading price of GREK and the reported NAV plummeted from about $12 to about $9 … and that’s about as bad as it ever got.
So it was a surprise to nobody when the fund ended up trading surprisingly stably on Monday, this first day of market opening, trading between $9.50 and $10 all day long. Meanwhile, the actual underlying securities whipsawed all over the place trying to re-establish equilibrium.
What Global X Got Right
In my opinion, Global X did several things to ensure that when the markets reopened, they were well positioned to peg the fair value of Greek stocks.
The first was adopting fair value NAV practices right away. The second was communicating quickly, clearly and with a regulatory filing on how they intended to value shares of GREK. The latter was to move as much of the portfolio as they could to ADRs, so that real-world securities could set the NAV as much as possible.
And I suspect that they also kept a constant stream of communication going with the authorized participant community about how and why they were adjusting their strategy and their valuations, which would explain this chart:
There are two surprises here. The first is just that the premiums were so constrained, and that, in fact, it was trading at a premium. But remember, GREK was one of the only ways for an investor to really express their opinion about how the exchange was going to open.
Everyone knew it was going to trade down, but how far down was a matter of opinion. That GREK traded at a premium suggests the market thought Global X’s best guess was actually too pessimistic.
However, since GREK never officially closed for creations and redemptions (instead, moving the portfolio toward the best basket of liquid ADRs they could manage), apparently nobody was willing to step up and book the arbitrage difference to “correct” the market prices.
The second big surprise is the complete lack of creation or redemption activity. Normally, when a fund trades to a premium, the AP community will step in to sell shares at that “inflated” price and buy underlying securities to feed to the issuer to make those shares. But in this case, despite high volumes and a lot of news, there have been zero flows. To me, that suggests that Global X got it exactly right.
The EGPT Lesson
Consider the difference with GREK with what happened back when the Market Vectors Egypt (EGPT | F-53) fund went through a similar market closure in 2011:
In that case, Van Eck had to actually deal with a more difficult problem, because while the local exchange closed, quite a few stocks in the underlying index were still trading in London.
That’s how you can see that creation (the blue flows column) happening even after the Egyptian exchange closed. So some of the prices used in calculating NAV were “real” from London, and some were “fair valued”—that is, guesses—from Egypt. And in this case, the premium peaked at more than 25 percent, before finally crashing down to where the market ended up opening.
But in this case, that premium was structural—Van Eck closed the fund after the last big creation at the beginning of February because there just weren’t enough ADRs or London shares to make new baskets. When the markets opened, the ETF crashed down to the market. When Greece reopened, the market crashed down to the value of the ETF.
Two different closed markets resulted in two very, very different outcomes. EGPT’s premium (and crash) was caused by structural lack of supply. GREK’s premium was caused by the AP community simply being uncertain about whether they could effectively book the arbitrage.
A lot has changed since 2011, but perhaps the most important change is that investors as well as issuers now know how the game is played. Institutional investors now understand how fair value pricing works. And to Global X’s credit, the firm’s immediate restatement of its NAV practices with a new prospectus, combined with an evident move to get as much of the portfolio into liquid ADRs of companies in the index as possible, reflected an issuer who understands how to manage an ETF in a time of crisis.
Changes Coming To GREK
While the pot may be off the boil for GREK, in fact, things are far from settled down.
First off, there’s the issue of whether MSCI will kick Greece out of the emerging markets. While this won’t impact the FTSE-based, single-country GREK, it will have a real impact on the country’s stock markets. MSCI is evaluating whether the situation in Greece warrants the temporary sidelining of the entire country, meaning major funds like the iShares MSCI Emerging Markets (EEM | B-99) would have to liquidate their holdings (where Greece is currently about 1 percent).
Even more interesting, however, is what the FTSE index tracked by GREK is even going to look like in a few months. With the significant devaluation of many of the financials in the heavily concentrated portfolio, firms like the local Coca-Cola affiliate, Coca-Cola HBC, are getting more weight (Coca-Cola is now more than 20 percent of the fund).
The index is due for a reconstitution at year end, and I think it’s safe to say that it’s going to look like a very different fund in six months. The index has 20 percent caps in its construction, which will inevitably get implemented, and a large swath of financials will likely fall out of the fund for simply being too small or illiquid.
Whether GREK remains an investor favorite as the news flow slows down remains to be seen, but with almost $300 million in assets under management, it’s certainly been successful. And if you’re one of those investors, now’s not the time to stop paying attention.
At the time of this writing, the author held no positions in the securities mentioned. You can reach Dave Nadig at firstname.lastname@example.org, or on Twitter @DaveNadig.