Hay has been made about exchange traded fund (
) tracking error, but a recent analysis shows that it's far from a
's ETF analyst Christos Costandinides has issued a report about the
causes of tracking error in 59 equity ETFs listed in Europe. He
concludes that "any tracking error of less than 50 basis points
[0.50%] in a year may not be worth worrying about. When it starts
to inch up toward 100 basis points [1%], then I would be concerned.
Above 100, I would be more alarmed."
Sophia Greene for Financial Times reports that
if tracking error is over 2%, it is not an index fund anymore.
Investors need to understand the sources of the tracking error,
however, before making a judgment on whether the ETF manager is
doing the job to the best of their ability, Costandinides says. [
Contango: Another Issue.
Tracking error is when a fund's performance veers from the
benchmark index that it is supposed to reflect.
Other causes of tracking error include:
- Fund fees. Even ETFs that track their benchmarks with
precision will underperform once fees are factored in. ETFs that
track the same index but have different fees will exhibit
- Illiquid holdings. This is more often a problem with emerging
reports Jessica Mead with City AM
- Index optimization. Sometimes it's necessary to optimize and
index because owning all the securities in the benchmark would be
cost-prohibitive. Statistical portfolio sampling may not always
work out as planned. [
Why More ETFs Had Tracking Error In 2009
Tisha Guerrero contributed to this article.