From Barron's Focus on Funds:
Exchange-traded funds can jump off the rails and trigger higher trading costs when disruptions hit their normal trading mechanism.
A good example cropped up on Wednesday, just hours after PowerShares announced that it “temporarily” suspended new creation units for 11 ETFs. Normally, specialized dealers work to create and destroy the number of ETF shares on the market. These dealers (called authorized participants) work with ETF companies to hammer an ETF’s price in line with the value of its holdings. This process keeps share prices for, say, the SPDR S&P 500 ETF (SPY) closely aligned with the S&P 500 index.
But look what can happen when there’s no way to expand the share count: the ETF can trade at a big premium. The $481 million PowerShares DB Oil Fund (DBO) is among the ETFs affected by PowerShares creation halt.
Soon after the opening bell, DBO’s price jumped way above its NAV. As illustrated below, it also rose well above prices for United States Oil Fund (USO) and the iPath S&P GSCI Crude Oil Total Return Index ETN (OIL).
The white line at the top is the price of DBO just before 11:00 a.m. Eastern, more than 2% above the other oil funds:
That premium quickly collapsed. Some traders appear to have gotten wise to DBO’s artificially high price and sold shares short, traders said. At the same time, oil prices rose. Less than an hour later, prices for the three funds had converged.
