ETFS – performance, tracking errors and their determinants in Europe and the USA

Abstract

Exchange-traded funds (ETFs) have grown considerably since their first introduction two and a half decades ago, becoming one of the most popular passive investment vehicles among retail and professional investors. However, their tracking ability is often questioned. In this paper we estimate tracking errors from a sample of 15 American and European ETFs utilizing three different methods. We find that American ETFs seem to exhibit lower tracking errors than European ETFs in all measurements of tracking error. We also analyse and discuss the factors that influence tracking error. Fund size and expense ratios are found to be affecting the tracking ability of ETFs. The results of this study concerning the performance and tracking error determinants of ETFs are consistent with the evidence presented in the literature. To our knowledge, this is the first study to compare American and European ETFs in terms of their tracking ability and their tracking error determinants.

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“…Later, most research on ETFs focused on their role as financial products. Several authors have investigated the effective relationship between benchmark indices and their ETFs ( Aber, Li, & Can, 2009 ), concluding in some cases that there are tracking errors ( Johnson, 2009 ) due to market frictions that can result in ETF performance that deviates significantly from the benchmark to which investors seek exposure ( Tsalikis & Papadopoulos, 2019 ). Recent research has also studied the effect of ETFs on asset prices ( Da & Shive, 2018 ; Dedi & Yavas, 2016 ), considering ETF ownership as a defining variable ( Israeli, Lee, & Sridharan, 2017 ; Agarwal, Hanouna, Moussawi, & Stahel, 2018 ; Evans, Moussawi, Pagano, & Sedunov, 2018 ), and the relationship between ETFs’ objectives, returns, and volatility ( Leippold, Su, & Ziegler, 2015 ; Malamud, 2015 ; Shank & Vianna, 2016 ).…”

Forecasting portfolio returns with skew‐geometric Brownian motions

“…We find that the RMSE and the MAPE are around 0.0325 and 0.0225, respectively. For comparison, in Tsalikis and Papadopoulos 51 the reported for studied ETFs is 0.0196 with a minimum of 0.0026 and a maximum of 0.0946. Similarly, in an earlier article on Seekingalpha about S&P index trackers, the was 0.0841 52…”

Investment Performance and Tracking Efficiency of Indian Equity Exchange Traded Funds

“…The presence of large tracking errors can be attributed to the existence of risk, management fees, non – full replication strategy, Asset under Management, volume traded, volatility, fund size, rebalancing events etc. (Frino and Gallaghar, 2001 ; Buetow & Henderson, 2012 ; Singh & Kaur, 2016 ; Dhume & Patil, 2019 ; Tsalikis and Papadopoulous, 2019 ; Goel & Ahluwalia, 2021 ). With regard to individual ETF’s, the minimum tracking error is related to BHARAT 22 ETF that tracks the S & P Bharat 22 Index and the maximum tracking error can be attributed to Edelweiss Exchange Traded Scheme- NIFTY that tracks NIFTY 50 Index.…”

“…Though ETF’s are cost- effective when compared to that of index mutual funds, management fees still lead to the performance deviation of ETF’s thereby affecting the returns generated by the ETF’s which is empirically explained through the inverse relationship results obtained the regression analysis (Elton et al, 2000 ; Fassas, 2014 ; Pinheiro & Varela, 2018 ). Various studies have also found a positive and significant relationship between expenses and tracking errors as expenses lead to tracking errors (Frino and Gallaghar, 2001 ; Rompotis, 2009 ; Chu, 2011 ; Rompotis, 2011 ; Rompotis, 2012 ; Singh & Kaur, 2016 ; Tsalikis & Papadopoulos, 2019 ).…”