Monday, July 23, 2012
ETF Tracking Errors
Barron's recently ran a piece on ETF tracking errors. In other words, you buy an ETF to track a particular index and the ETF does not closely match the performance of the index it is supposed to track. There are various reasons for the error, including fees, trading costs, and failure of the ETF to match the indices' holdings closely enough. The article generally notes that tracking errors are small on US indices. Frankly, this wasn't my understanding, at least with respect to triple short and triple long ETF's, but this isn't the point of my entry. The article also suggests that foreign index ETF's have greater tracking errors. Is there an arbitrage opportunity here, e.g. can you sell short one of these foreign index ETF's and then perhaps go long all or many of the underlying holdings of the ETF. The idea being that your direct holding of the components of the index will outperform the ETF? This one's not for me, it's a purely institutional trade I think and the devil would be in the details. Trading costs might simply be too high with respect to buying the index's components.