Why international ETFs trade at a premium

In the Indian stock market, international exchange-traded funds (ETFs) often trade at a premium rather than reflecting the true value of their underlying assets. This premium can exceed 10% or even 20%. The premium arises because of a regulatory cap imposed on Indian mutual funds, which limits their collective ability to invest overseas.

When demand for these ETFs remains high but new investments cannot be made due to the cap, the supply of ETF units becomes fixed while demand persists, driving up prices. Normally, if the market price surpasses the net asset value (NAV) – the value of the ETF's holdings divided by the number of units – authorized participants step in to create new units and sell them at NAV, correcting the premium.

However, with the overseas limit exhausted, this arbitrage mechanism cannot correct the price discrepancy. The premium may correct itself when the overseas investment limit is lifted or market sentiment changes, but there is a risk of a sharp decline if this does not happen. Before investing in an international ETF, one should verify four factors: whether the fund is accepting new subscriptions, the current size of the premium compared to the latest indicative NAV, whether the premium has been stable historically, and if a fund of funds providing a more direct and potentially cheaper route exists.