The premium that never leaves you alone

Summary: If you buy an overseas ETF at a premium and the premium holds, your return matches the index. That sounds reasonable — until you see how much you overpaid to get there. If the premium shrinks, which it eventually will, you can still lose money when the index rises. Here’s why.

If you’ve built a sizable portfolio, adding international exposure feels like the next sensible step. When markets abroad outperform India, you get to participate in that upside.

The logic seems sound at first glance.

But when you dig deeper into overseas ETFs, you realise something important.

You’re not just buying global markets. You’re buying them at a markup.

And that markup quietly decides how much of that outperformance you actually get to keep.

That’s why we’ve done the math.

But first, why do these ETFs trade above their actual value?

The Mirae Asset NYSE FANG+ ETF’s premium is at 27.7 per cent. Also, three funds from the list have been above their NAV for the entire last year. To see what this costs you, consider two scenarios.

Scenario one: The premium stays as is

You invest Rs 1 lakh at a 20 per cent premium. The underlying assets are worth Rs 83,333 (not Rs 80,000). The index rises 10 per cent. NAV moves to Rs 91,667. The premium holds. Your market price goes from Rs 1,00,000 to Rs 1,10,000. Therefore, your return is 10 per cent, and matches the index.

This looks fine. But you paid Rs 1 lakh for Rs 83,333 of assets. That Rs 16,667 is not a fee that gets refunded. It is wealth permanently transferred to whoever sold you the units, as they pocket the premium. The percentage return matches the index, but you parted with more money to get there. Over time, as the premium persists, this overpayment compounds.

Scenario two: The premium shrinks

You again enter at Rs 1 lakh at a 20 per cent premium with a NAV of Rs 83,333. Now, the index rises 10 per cent and your exit NAV is Rs 91,667. However, the premium has fallen from 20 to 10 per cent. Your market price remains Rs 1,00,833 and not the earlier Rs 1.1 lakh. Therefore, you undershoot the index’s return of 10 per cent by making a return of 0.8 per cent.

A rising index is not enough. Your return depends on what happens to the gap between the price you paid and the value you own. If that gap narrows, your returns take the hit — regardless of whether the index rises or skyrockets.

Will the premium compress?

Some premium is the price of admission to global ETFs right now. Unit creation is frozen, demand has not gone away, and the gap between market price and NAV is structural, not accidental. Accepting a small premium is a reasonable trade-off for global diversification. Accepting a large one is a different matter entirely.

Here is why. If you buy at a 3 per cent premium and it fully compresses to zero, you need the index to deliver 15.4 per cent to earn your 12 per cent return — a gap of 3.4 percentage points. Uncomfortable, but survivable. If you buy at a 20 per cent premium and it compresses only halfway — to 10 per cent — you need the index to deliver 22.2 per cent just to earn that same 12 per cent return. If it goes all the way to zero, the index needs to deliver 34.4 per cent.

And this is where the real risk sits. The Nasdaq and the S&P 500 have had strong years — but 22 per cent, 34 per cent returns are far from a certainty. You are not just betting on the index. You are betting on the index delivering outsized returns specifically to compensate for a premium you paid on the way in. That is a much harder bet. The higher the premium you accept at entry, the more you are relying on the index to deliver uncharacteristically high returns.

As the ceiling of USD 1 billion has been hit, only certain international funds are accepting investments, whether it is a lump sum or an SIP. To help you keep track of these funds opening up their doors, we’ve started including a list of this in Mutual Fund Insight. To check out the entire list of these funds, subscribe to the latest issue of the magazine.

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Also read: Indians get a new route to the world's markets via GIFT City