The Wild West Of ETF Performance

March 22, 2019

[Editor’s Note: The following originally appeared on Elisabeth Kashner is director of ETF research and analytics for FactSet.]


When there’s no good answer to a basic question, it’s time to ask for a better one.

Investors and ETF asset managers want to know how an ETF performed over the past week, month or year. Often, they want to compare ETF performance, to see how their fund did versus its competition. They might also want to measure tracking difference or end-of-day premium/discount levels.

Often, all they get is frustrated. Shockingly, it is nearly impossible to make a fair, apples-to-apples comparison within an ETF market segment.

The most reliable metric of a fund’s valuation, the end-of-day net asset value, or NAV, can be calculated in two ways. Each tells a valid story, one which stands on its own. But too often they cannot stand together. The time is ripe to standardize NAV calculation requirements.

Pick Your Poison

NAVs can be designed to minimize calculated tracking difference or premium/discount. Often, it’s not possible to do both, because ETF asset managers must choose an NAV accounting method for setting each portfolio security’s closing price, along with a time of day for foreign currency conversions.

For two-thirds of all U.S. ETFs, the choice is a bitter one. Aligning strike times with capital market closings minimizes premiums/discounts, but can wreak havoc with tracking difference. Synchronizing with benchmark valuation tightens tracking difference but blows out premium/discount results.

The result: Major asset classes, including international equity, all fixed income, commodities and currencies have overstated tracking error or trading costs. U.S. equity portfolios are the only major group spared the trade-off. 

Benchmark Style

The “benchmark” style minimizes tracking error, at the expense of premium/discount. The “no lawsuits” style, born in response to the mutual fund timing scandal, minimizes the levels of premium/discount because all currency valuations happen at 4 p.m. ET. This comes at the cost of higher tracking error, as custodian-style funds are not aligned with index valuation practices.

This trade-off is evident in equity funds holding foreign stocks such as the iShares Core MSCI Emerging Markets ETF (IEMG), which follows benchmark conventions, and the Vanguard FTSE Emerging Markets ETF (VWO), which follows "no lawsuits" conventions, lowering (but not eliminating) premium/discount at the expense of tracking error. 

The charts below contrast each fund’s daily premium/discount with its daily tracking error. The premium/discount is shown in blue and the tracking error in orange. 

Blue premium/discount dominates IEMG’s chart, to the point where orange tracking error is nearly invisible. 



(For a larger view, click on the image above)


Both colors are visible in VWO’s chart, but orange tracking error stands out, while blue premium/discount is more muted. 



(For a larger view, click on the image above)


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