Last year, exchange traded funds (ETFs) managed to cut down on tracking error – the divergence between a fund and its benchmark index. That said, tracking error will never be entirely eradicated.

Ian Salisbury for The Wall Street Journal reports that in reality, ETFs almost never precisely accomplish perfect tracking. That’s not a flaw: investment fees, changes to indexes and tweaks by investment companies to make ETFs cheaper and easier to trade can all contribute. [ETF Tracking Error: The Exception, Not the Rule.]

Here’s a rundown of which funds are hitting, and which are missing:

  • Morgan Stanley Smith Barney said ETFs that target the U.S. stock market missed benchmark returns by 0.57 % on average in 2010, compared with 0.84 % in 2009.
  • Among international funds, which tend to have higher costs and target securities that are harder and more expensive to trade, discrepancies were wider, but they narrowed from 2009. On average, international ETFs missed their mark by 1.1 % versus 1.94 % in the prior year. [7 Winning ETF Characteristics.]

About 11 ETFs had tracking error of 3% or more. The report from Morgan Stanley didn’t explain the reason behind the general improvement, but some figure that a reduction in market volatility combined with growing ETF assets may have helped.

Tisha Guerrero contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.