Last year may have been a breakout year for exchange traded funds (ETFs), but some ETFs did not perform as well as they should have. The disparity between ETFs and the benchmarks they try to reflect widened.
According to a study conducted by Morgan Stanley (NYSE: MS), ETFs veered away from their benchmarks by an average of 1.25% in 2009, a gap more than twice as much as the 0.52% average for 2008, reports Ian Salisbury for The Wall Street Journal. [Causes of Tracking Error in ETFs.]
Everyone focuses on the benefits of ETFs – transparency, low fees, intraday liquidity and so on – but if they fall short of their indexes, they lose their advantage over active mutual funds and ETFs that do track their benchmarks. As ETFs grow, it’s important that they perform as closely as possible to their benchmarks.
The tracking error is seen as a result of the recent proliferation of ETFs that target niche investments or areas where trading is less liquid. 54 ETFs had tracking errors of more than 3% and some even had more than 10% last year. For instance, the iShares MSCI Emerging Markets Index (NYSEArca: EEM) gained 71.8% in 2009 while the benchmark returned 78.5%.