How to keep track of tracking difference

Posted by Robin Powell on January 20, 2016

 

There aren’t many blogs (other than this one, of course) that evidence-based investors ought to follow. But Monevator is definitely one of them. It’s very well-written and brimming with insight and useful advice. Although it’s UK-based, it appeals (as we aim to do) to an international audience.

Monevator’s recent post on tracking difference is a gem. Together with this earlier post, there’s everything here you need to know about this very important subject.

We’d encourage you to read the whole thing but, for the time-poor, here are the key takeaways.

What it is:

“Tracking difference shows you how far a tracker fund (that costs money) falls short of the performance of its index (that costs nothing).”

(Note: Tracking difference should not be confused with tracking error, which is about variability rather than performance.)

Why it’s important:

“(Tracking difference) is the true cost of owning the fund, regardless of what the factsheet might claim.”

How to uncover it:

“Until now, tracking difference has been a devil to calculate and compare across funds. But now one of the investment data providers, Trustnet, has taken a very good stab at tracking difference in its new passive funds section.”

What to look for:

Tracking difference can fluctuate over time and that’s why many commentators recommend plumping for a tracker that hugs its index tightly as evidence of good management practices – regardless of whether the difference is positive or negative.”

The UK tracker with the lowest tracking difference:

“L&G Index I.. actually beat the return of the index by 0.05% per year (over the last three years) and effectively paid you for owning it. Very nice of them.”

What to beware of:

“When making your comparison, be sure you are comparing like with like when it comes to the indexes (or benchmarks). For example, FTSE All-Share funds are very different beasts to FTSE 250 funds. In contrast there’s little meaningful difference between the FTSE Emerging Markets and MSCI Emerging Markets indices.”

Award your own stars:

“Trustnet has also thrown in a one-to-five-stars rating system. (But its) methodology includes a weighting to tracking error and fund size, which I believe are much less important to buy and hold investors. Personally, I’d rather be guided by tracking difference and a review of the most important features of the factsheet.

Read the full article here

 

Robin Powell

Robin is a journalist and campaigner for positive change in global investing. He runs Regis Media, a niche provider of content marketing for financial advice firms with an evidence-based investment philosophy. He also works as a consultant to other disruptive firms in the investing sector.

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