For both equity and fixed income ETFs, the quoted market price of each ETF is typically displayed as the midpoint of its bid and ask, which reflects the bid and ask prices of the underlying securities. An equity ETF’s end-of-day net asset value (NAV) will then be based on the closing prices of the underlying securities.
For a bond ETF, however, the NAV is struck using the bid-side pricing of the underlying securities, as the chart below shows. That lower NAV means that bond ETFs typically close at a premium on a daily basis.
Because all bond ETFs are priced this way and all bonds exhibit this bid-side pricing as a matter of course, it’s critical to evaluate the consistency of the premium in a given ETF, not just its mere existence, as you seek to determine fair value of a given bond ETF.
Put differently, if a fixed income ETF is trading at a premium, investors might be concerned about a potential “baked in” loss upon sale. However, if the premium is consistent, the risk of that baked-in loss is mitigated.