How well does your ETF track its index?

The ideal index fund would deliver the precise return of its benchmark, but we all know that’s not realistic. ETFs and index funds may be cheap but they’re not free, and fees almost always cause them to lag slightly. Index investors accept this because they know the alternatives are usually much worse, but they can’t be too complacent. It’s important to periodically check your ETF’s tracking error: that is, the difference between the index return and the fund’s actual performance.

Where do you find this information? Over at iShares, you simply visit the ETF’s web page and click the “Performance” tab. You’ll see the returns of both the fund and its index over various periods from one month to 10 years, as well as calendar-year returns. iShares currently lists fund returns according to net asset value (NAV) only: the market price field is blank. For example, over the 12 months ending March 31 the iShares S&P/TSX Capped Composite (XIC) lagged its index by 29 basis points:

The process is almost identical at Vanguard: again, simply visit the ETF’s web page and click the “Performance” tab. Vanguard includes returns based on both NAV and market price, so you can compare both to the benchmark. Here’s what the numbers look like for the Vanguard Canadian Aggregate Bond (VAB):

Unfortunately, BMO really drops the ball here. Using the BMO Equal Weight REITs (ZRE) as an example, you can click the Prices & Performance tab and find a link to a Tracking Error Chart, but the info is displayed only in graphical form. You can download an Excel spreadsheet with the raw data, but good luck using that to determine anything useful.

You can’t cover your tracks

Alas, no one can escape the scrutiny of a resourceful Couch Potato. That’s because every mutual fund and ETF in Canada is required to file a Management Report of Fund Performance (MRFP) twice a year. This document includes a lot of valuable information, including your fund’s recent performance in relation to its benchmark. The format is a little different for each company, but the information appears under the heading “Results of Operations.” For 2012, the fund’s MRFP reveals XRE’s tracking error was 76 basis points:

To BMO’s credit, they make it easy to find the MRFPs for all their ETFs on a single web page. (To get there click the “Legal & Regulatory Documents” link at the bottom of any ETF page.) Vanguard also makes your job easy by including an “Annual MRFP” link on the right-hand side of every ETF’s web page. But iShares doesn’t provide a link at all. Neither does Horizons, nor the TD e-Series funds. However, you can always find your fund’s MRFP by visiting SEDAR, where companies are required to post their regulatory documents. Just key in the name of the fund and select “Management Report of Fund Performance” from the pull-down menu.

Next week I’ll share the performance results of some popular index funds, including some pleasant surprises and a few disappointments. I’ll also describe the many factors that contribute to tracking error in your portfolio.