ETF composition risk can be another term used to describe tracking error risk. If two or more ETFs used different methodologies and/or baskets of securities to track an index, they may end up with different performances. Synthetic replication via swaps can perform differently to cash or physical replication via directly holding the underlying securities, in part because swaps can entail additional embedded costs.
Moreover, swaps are often based on derivatives such as futures, which can trade above or below fair value versus the underlying cash. And tracking an index by taking a sample can perform differently from owning every part of the index or fully replicating it. Various combinations and interactions of the above approaches can result in more potential for divergent performance.
Accurate performance calculation needs to take account of several factors that can lead to errors if they are overlooked. Some ETFs distribute income and others roll it up inside the ETF. For distributing ETFs, the total return performance calculation needs to include some assumption about when the income was reinvested, which can be further complicated by the different tax treatment of income and dividends in different countries.
The same currency share class should also be used to measure performance over time, because currency hedging, errors thereof (or the absence of it) can add to or detract from returns on different currency share classes. The ETF price should be used because the underlying NAV of the ETF may not always track its performance perfectly on the relatively rare occasions when ETFs go to significant premiums or discounts versus NAV.
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A single, flexible, dynamically updated API oils the wheels of buyside operational routines, in contrast to multiple customised files that can be slow to update and leave operational teams and algorithms grappling with a messy jigsaw.
Index modules are the building blocks of an index. For instance, event modules will include corporate events such as M&A and spinoffs, corporate actions such as dividends, stock splits and rights issues, index rebalances including additions, deletions and re-weightings.
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