Why two index trackers might give very different results
ETFs have come a long way since the first listing in Europe over a decade ago. Technological improvements, enhanced portfolio optimisation techniques and booming demand mean ETF providers have become better at keeping their promises and faithfully tracking their indices.
Performance matters in the long run
But we're not yet at the stage where ETFs are fully commoditised products. Providers tracking the same indices can still perform very differently.
Over the past year for instance, the difference between the worst and best performing Euro Stoxx 300 ETF was over 1.2%.1 This may not sound like a lot, but with the power of compounding, underperforming ETFs can significantly eat into your returns in the long run.
The table below shows just how different the performance can be, even on some of Europe's most mainstream indices. What it also shows is that in 6 out of 10 cases Lyxor ranked number 1 for tracking difference over the past year, and ranked number 2 for the remaining four indices.1
Performance summary of ETFs in Europe tracking mainstream equity indices
|
Index name |
Exposure |
Index 1Y performance |
Worst performing ETF |
Best performing ETF |
Lyxor rank |
|
Eurozone equities |
22.35% |
23.42% |
24.66% |
#1 |
|
|
Spanish equities |
21.89% |
22.24% |
22.39% |
#1 |
|
|
Italian equities |
41.77% |
41.74% |
42.04% |
#1 |
|
|
US large caps |
18.37% |
17.73% |
18.46% |
#12 |
|
|
US small caps |
14.32% |
14.08% |
14.96% |
#1 |
|
|
US non-financial large caps |
17.52% |
17.16% |
17.55% |
#2 |
|
|
Developed Pacific equities ex-Japan |
8.79% |
8.26% |
8.73% |
#2 |
|
|
Japanese equities |
8.67% |
8.45% |
8.53% |
#1 |
|
|
Global developed & emerging equities |
12.79% |
12.45% |
12.67% |
#2 |
|
|
UK equities |
9.17% |
9.01% |
9.18% |
#2 |
1Source: Lyxor International Asset Management, Bloomberg. Data as at September 29, 2017. Past performance is not a reliable indicator of future results. The rationale behind the methodology is detailed in an academic paper published by Marlene Hassine, ETF strategist. The academic paper can be downloaded from SSRN: http://ssrn.com/abstract=2212596 or from REPEC http://ideas.repec.org/p/pra/mprapa/44298.html
2First place rank for 1 year tracking difference tied with one other ETF.
Securities lending - a boost or a burden?
Why do these performance gaps exist? Simply put, tracking an index is not as easy as it sounds. Corporate actions, tax, and the treatment of dividend payments are just some of the things ETF portfolio managers have to take into account.
One common way to help boost performance is through a robust securities lending programme. In some cases, expert management can lead to the ETF actually outperforming its index. Bear in mind though that practices may vary from provider to provider. At Lyxor for instance, we have strict caps on lending, and make no compromises when it comes to the collateral we will take as security, ensuring it is entirely consistent with the assets out on loan (i.e. bond for bonds, equities for equities). Some providers on the other hand can have up to 100% of assets out on loan, and accept stocks as collateral for their government bond ETFs - a riskier proposition.
How to pick a leader and avoid a laggard
While past performance is no guarantee of future returns, we recommend looking into the following factors when deciding which ETF is right for you.
- Cost
The Total Expense Ratio is an annual charge that will have a material impact on tracking difference. Though it is far from the only factor that affects ETF performance, keeping your costs low is one of the easiest ways to avoid being a laggard.
- Replication type
Depending on the underlying index, it may make sense to opt for full physical replication to keep things simple, or synthetic replication where the underlying exposure is perhaps more complex or less liquid. At Lyxor, we are pragmatic replicators so we choose what we think is best for investors.
- Fund size and liquidity
As a rule of thumb, the bigger the fund, the more often it tends to trade, which means the bid/ask spread is more attractive. Believe it or not, this can have a bigger impact on performance than the TER.
- Track record
It helps to choose an ETF which has been around for at least a few years, and has a decent track record.
Ultimately, one of the safest bets you can make is to choose an experienced, dependable provider. This should give you the peace of mind you need to focus more on what matters more than anything - getting your allocation right!
Find out more about ETF Efficiency at LyxorETF.co.uk
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