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The policy is most commonly used when valuing foreign securities. Some ETF providers use fair-value pricing if the value of a security it holds has been affected by events occurring before the local market's close but after the close of the primary markets or exchanges on which the security is traded. Fair-value pricing is applied because the market value may be stale and not a real reflection of the securities' actual (fair) value. As a result, they also have a direct impact on an ETF's performance and any tracking difference.įair-value pricing is an adjustment to a closing price designed to correct pricing discrepancies caused by time zone differences among the global financial markets. Withholding taxes on dividends in the underlying portfolio are reflected in the ETF's net asset value. Those taxes should be considered when analyzing and comparing the performance of ETFs. Fully replicated ETFs tend to have lower tracking errors than optimized and sampled ETFs.ĭepending on the domicile of the ETF, there may be withholding taxes both on dividends in the underlying portfolio and also on distributions of the ETF itself. Replication methodology can be a major contributor to both tracking error and tracking difference. A manager must also be adept at handling index constituent changes, index reconstitutions, fund cash flows and more.
Index account tracker full#
They can vary over time and consequently can be an important cause of tracking error and tracking difference.Ī good index fund manager will understand when to use a full replication approach and when a sampling or optimization approach may be more appropriate.
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Swap fees associated with synthetic ETFs are also not included in the MER. Be sure to evaluate all of a fund's fees, including the trading costs, which are not included in the management expense ratio (MER). However, from a practical standpoint, a number of factors work to make that ideal impossible to achieve.īy creating a drag on performance, fees are the most common contributor to negative tracking difference. In an ideal world, ETFs would perfectly track their benchmark indexes and tracking difference and tracking error would not exist. Key causes of tracking error and tracking difference Other factors, such as asset allocation, index methodology and cost should also be evaluated before selecting an investment. When comparing funds in real life, you might not find such a clear-cut trade-off between tracking difference and tracking error. However, investors who value returns that don't deviate too far from the benchmark may be attracted to Fund B, despite its lower average returns (i.e.
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In the hypothetical example shown here, investors seeking stronger long-term returns may find Fund A the better choice, despite its higher tracking error. However, over the short term, you may care more about performance consistency and want to minimize volatility, in which case you may wish to focus on tracking error. If your primary objective is seeking total return over a long-term time frame, then excess return is a more important measure than tracking error. A lower tracking error would suggest lower variability of the excess return. In other words, while tracking difference measures the amount by which an ETF's return differs from that of its benchmark over a specified period, tracking error measures the variability of tracking difference over time.įor example, if the tracking error is 50 basis points, about two-thirds of the time the ETF's excess returns are expected to be within 50 basis points of the average excess return. The formal definition of tracking error is the annualized standard deviation of tracking difference. Purchase and redemption fees (paid to fund)ĮTF providers define tracking error in different ways. Tracking difference can be positive or negative and reveals the extent to which an ETF outperforms or underperforms its benchmark index. Calculating tracking difference is fairly simple: Subtract the index's total return from the ETF's total return. Tracking difference measures an ETF's performance against its benchmark index over a specific period of time. Understanding what they measure can help you make smarter investment decisions. Tracking difference (sometimes referred to as excess return) and tracking error are important metrics to consider, especially when evaluating traditional index ETFs.