Patterns in ETF Tracking Errors: ESG vs. Non-ESG Passive Equity Exchange-traded funds

In 2014, ProShares CEO Michael Sapir was meeting with Steve Cohen, managing director and head of the ProShares Strategy Group, whose agenda centered on the progress the firm was making in moving from its core offering of geared ETFs into establishing itself as the leading alternative ETF company. Since 2009, the firm had launched an array of ETFs and Sapir and Cohen were reviewing the current lineup, the assets under management (AUM), and net flows across ProShares' different ETF categories. Could ProShares get another $25 billion in AUM in these more strategic alternative ETFs? Excerpt UVA-F-1729 Nov. 24, 2015 ProShares: The Alternative ETF Company In the summer of 2014, Michael Sapir, the CEO of ProShares, was reviewing the progress in the firm's lineup of exchange-traded funds (ETFs). With its headquarters located in Bethesda, Maryland, the firm was far from Wall Street and was a nontraditional financial company in many respects. Since its first ETF launch in 2006, the firm had successfully democratized access to short and leveraged strategies by offering them in ETFs to individual investors, advisers, and institutions. These “geared” ETFs aimed to deliver two or three times the daily return or the inverse of the return of their underlying indices covering all the major asset classes such as domestic equities (including different market caps, styles, or sectors), international equities, fixed income, commodities, and currencies. ProShares ranked in the top 10 of the largest ETF sponsors in the United States. Sapir was meeting with Steve Cohen, managing director and head of the ProShares Strategy Group whose agenda centered on the progress the firm was making in moving from its core offering of geared ETFs into establishing itself as the leading alternative ETF company. Offering alternative ETFs was a broad concept that encompassed both nontraditional asset classes and investment strategies (Exhibit 1). Although these investments aimed to provide unique sources of risk and return, correlation benefits, and the potential for a better Sharpe ratio in a portfolio, they also might provide potential downside protection in falling markets. These alternative strategies, used for some time by institutional investors, tended to have favorable long-term returns relative to risk. Many of these strategies used leverage, shorting, and derivatives. Since 2009, the firm had launched an array of ETFs that included alternative equity (specialty equity and dividend growers), fixed income strategies (hedged and global fixed income), tactical products to benefit from changes in inflation and market volatility (inflation and volatility), and ETFs that replicated hedge fund strategies (hedge strategies). (See Exhibit 2 for the full product list.) Sapir and Cohen were reviewing the current lineup of ETFs, the assets under management (AUM), and net flows across ProShares' different ETF categories (Exhibit 3). ProShares had become the world's largest manager of geared ETFs with more than $ 25billion in AUM (Exhibit 4). Could it get the next $ 25 billion in AUM in these more strategic alternative ETFs? . . .

The present study attempts to examine the tracking ability of Indian equity exchange traded funds (ETFs) across the bearish and bullish market regimes. Also, ETFs’ sensitivity to their respective underlying indices across the two market conditions is examined so as to gain an insight into the differences in risk exposure under the two regimes using DBM. The results found that the tracking error (TE) of ETFs varies across the two market regimes with it higher during the bullish regime. At the same time, ETFs’ responsiveness to their underlying indices is found to be higher during the bearish market regime, which justifies the existence of lower TE during the bearish regime. NIFTYBEES, KOTAKNIFTY and BANKBEES emerged to be the top three performers in terms of tracking efficiency. Further, NIFTYBEES, BANKBEES and JUNIORBEES are reported to provide significantly positive excess returns during the bullish regime. As such, investors considering investment in equity ETFs can opt for the top performing funds where they also stand a chance to earn excess return (in few cases). Also, it is observed the beta coefficients of ETFs varied significantly from unity. It suggests that the ETFs and their respective underlying indices are not subject to similar systematic risk.

This article presents some key figures about the European market for exchange-traded funds (ETFs), with a focus on growth, key trends, and impact on underlying instruments. One particular important area of growth is the environmental, social, and governance (ESG) ETF segment, with the market size in Europe exceeding that in the United States both in terms of assets under management (AUM) and number of products, although the gap has tended to decrease slightly over time. Turning to ETF ownership, the authors find several reasons to expect the impact of ETFs on European equity markets to be more modest than that documented in the academic literature for the US equity markets, namely a materially lower level of average ETF ownership and a primarily international ownership (i.e., located in the United States). These figures are put in perspective with the results of a survey carried out during the first quarter of 2021, which provides insights into European professional investor perceptions of ETFs. The survey also reveals a particularly strong appetite for ESG-themed funds, and ETFs appear to be a useful instrument for integrating an ESG component into investment decisions. <b>TOPICS:</b>ESG investing, exchange-traded funds and applications, developed markets, performance measurement <b>Key Findings</b> ▪ ETF ownership of European stocks is about half that of US stocks; the European ESG ETF market size exceeds that in the United States, both in terms of AUM and the number of products, but incremental AUM are now almost on par. ▪ European investors show great interest in SRI/ESG investment, with 55% of ETF users already investing in SRI/ESG in 2021 and 68% of those who have not yet done so considering integrating ESG into their portfolios in the near future. ▪ ETFs appear to be a useful instrument for integrating an SRI/ESG component into investment, with 67% of respondents using them to do so and 60% wishing to see further developments in SRI/ESG-based ETFs and/or low-carbon ETFs.

This study investigates the performance of the largest U.S.-domiciled exchange-traded funds (ETFs) focused on large-cap equities by assets under management (AUM), covering the period from 2010 to 2024. ETFs play a central role in modern investing, offering low-cost, diversified, and liquid access to broad market exposures. While previous research has examined various ETF categories, this paper concentrates on the core group of top equity ETFs that dominate investor portfolios. Using a set of well-established performance metrics—total return, average annual return, standard deviation, alpha, beta, Sharpe ratio, and Treynor ratio—the analysis assesses both absolute and risk-adjusted performance across eight ETFs. The results reveal notable differences in return generation and risk efficiency, even among funds with similar investment styles. Growth-oriented ETFs generally delivered higher returns but also exhibited greater volatility, while more conservative or value-focused ETFs showed mixed outcomes. The ranking model applied in this study helps clarify which ETFs achieved superior overall performance based on a balanced evaluation of return and risk. The findings highlight the importance of multi-metric analysis when selecting ETFs for long-term investment strategies.

Exchange-Traded Funds (ETFs) have revolutionised the asset-management industry with high liquidity and low bid-asks allowing investors to access a diversified portfolio cheaply. The desirable liquidity characteristics of ETFs are, however, in contrast with their behavior in crisis periods. This paper studies the breakdown in the fixed-income ETFs (FIETFs) market, during the peak of the COVID-19-driven liquidity shock of March 2020. We argue that FIETFs provide an illusion of liquidity and the liquidity mismatch between the ETF and the underlying manifests itself in terms of very significant differences between the price and the Net Asset Value (NAV). We run a further analysis on the dislocation by comparing it with equity ETFs. Comparisons suggest that the cost of liquidity is very high for fixed-income ETFs with significant tracking errors during volatile periods in contrast with the better-behaved equity ETFs. Further analysis on the performance patterns of FIETFs indicates that both the price and NAV might have deviated from fundamentals with an overreaction in the ETF price accompanying an underreaction in the NAV. We also study the phenomena of ‘dealer inventory management’. FIETFs are uniquely different from equity ETFs in that the authorised participant (arbitrageurs) tend to be the large banks that are also market-makers in the underlying securities. Therefore, we show that the incentives of the arbitrageurs may not always be aligned towards arbitraging the price-NAV differential. In a novel empirical study using trading volumes and position changes for the largest corporate bond ETF (LQD), we suggest that inventory management by the larger broker-dealers may have exacerbated the dislocation. We believe that the conflicting objectives of dealers have further increased due to high balance-sheet costs imposed upon them post the Global Financial Crisis. Finally, we propose the use of derivatives, in particular credit derivatives, for the risk management of liquidity shocks. We show that the drawdown from rapid liquidity shocks can be reduced significantly through exposure to credit convexity.

This article focuses on the replication process of exchange-traded funds (ETFs). It compares the tracking ability of ETFs based on physical replication of their benchmark indexes to those of synthetic ETFs. Synthetic ETFs rely on derivatives such as swaps. For ETFs listed at the Frankfurt Stock Exchange, we show that both categories of ETFs suffer from high tracking errors. Contrary to conventional wisdom, synthetic equity ETFs are not different in terms of tracking errors from their physical counterparts. However, synthetic fixed-income ETFs have lower tracking errors than physical fixed-income ETFs. Thus, synthetic ETFs have as good or better tracking errors than physical ETFs. We identify different factors influencing tracking errors.

Tracing financial innovation diffusion and substitution trajectories. Recent evidence on exchange-traded funds in Japan and South Korea

PurposeThe purpose of this paper is to assess whether exchange‐traded funds (ETFs) can beat the market, as it is expressed by the Standard and Poor (S&amp;P) 500 Index, examine the outperformance persistence, calculate tracking error, assess the tracking error persistence, investigate the factors that induce tracking error and assess whether there are predictable patterns in ETFs' performance.Design/methodology/approachThe author uses a sample of 50 iShares during the period 2002‐2007 and calculates the simple raw return, the Sharpe ratio and the Sortino ratio, regresses the performance differences between ETFs and market index, calculates tracking error as the standard deviation in return differences between ETFs and benchmarks, assesses tracking error's persistence in the same fashion used to assess the ETFs' outperformance persistence, examines the impact of expenses, risk and age on tracking error and applies dummy regression analysis to study whether the performance of ETFs is predictable.FindingsThe results reveal that the majority of the selected iShares beat the S&amp;P 500 Index, both at the annual and the aggregate levels while the return superiority of ETFs strongly persists at the short‐term level. The tracking error of ETFs also persists at the short‐term level. The regression analysis on tracking error reveals that the expenses charged by ETFs along with the age and risk of ETFs are some of the factors that can explain the persistence in tracking error. Finally, the dummy regression analysis indicates that the performance of ETFs can be somehow predictable.Originality/valueThe findings of this paper may be of help to investors seeking investment choices that will help them to gain above market returns. In addition, tracking error‐concerned investors will be helped by the findings of the paper. Finally, the findings on return predictability can also be helpful to investors.

This study measures the tracking errors of exchange traded funds (ETFs) listed in Bursa Malaysia. Five measures of tracking errors are estimated in this study for the seven ETFs involved. Overall, the best ETF is METFAPA with the least tracking error. The ranking of the remainder ETFs, in the ascending order of tracking error is MYETFID, METFSID, MYETFDJ, CIMC50, FBMKLCI-EA and CIMBA40 (highest tracking error). The findings in this study is expected to provide clue for passive institutional and retail investors on their selection of ETFs to mimic the portfolio of the desired underlying assets. Moreover, it is anticipated that these findings will motivate the improvement in the tracking ability of the existing ETFs, solicit more follow up studies to encourage the development of new ETFs and increase the participation of investors.

Objective. This paper focuses on UK leveraged Exchange Traded Funds (ETFs) and examines their ability to meet their daily targets, the impact of volatility on targets’ achievement, and their pricing efficiency.Methodology. Standard regression analysis is used to evaluate performance, tracking efficiency and persistence in tracking failures, and the relationship between tracking efficiency and market volatility. Moreover, the pricing efficiency is examined along with the persistence in premium and the influence of market factors on premium.Findings. Results reveal that ETFs achieve their targets but occasionally tracking error can be significant. Furthermore, increases in market volatility relate to higher and lower tracking errors for bull and bear ETFs respectively. Moreover, average premiums testify a sufficient fit between trading prices and net asset values whereas the premiums are eliminated sharply. Moreover, the pricing efficiency of bear ETFs is positively associated with benchmark returns. The opposite is the case for bull ETFs. Finally, the pricing deviations are positively related to benchmarks’ volatility.Limitations. A possible limitation is that our sample includes just nine bear and sixteen bull ETFs even though more than 90 leveraged ETFs are traded on the UK market and our results may not be indicative of the entire UK leveraged ETF market. However, we had to use a small sample of ETFs because the trading activity of the rest ETFs has been very poor and, consequently, our analysis could have been biased by a thin trading effect. Originality/Value. This is the first study to examine the UK market of leveraged ETFs.

This paper investigates the seasonal characteristics of exchange traded funds (ETFs) return, risk, tracking error and volume and reveals the existence of a strong November effect in performance. On the other hand, this study finds that the well-known January effect does not affect the performance of ETFs. Moreover, this paper demonstrates that a semi-strong seasonality effect on ETFs' risk exists in November and that ETFs achieve their best index replication in this month. The combination of substantial average performance and low average risk and tracking error signals an opportunity for investors to gain sufficient returns by exposing themselves in modest or low volatility and tracking failure. A straightforward relationship between risk and tracking error is also revealed. Finally, the study indicates that the trading activity of ETFs is lacking in any seasonal pattern but there is some evidence on the direct conjuncture between risk and volume. This connection implies that ETF investors sell their shares when their investments in ETFs are over risky.

Leveraged Exchange Traded Funds (ETFs) (LETFs) are a recent and highly successful financial innovation; yet, investors and several studies criticized them for not performing as advertised, especially in the long term. Τhis paper discusses their unique characteristics and their path-dependent price dynamics, which may result in unexpected returns. Furthermore, the authors evaluate the performance of a large sample of European and American leveraged ETFs since each fund’s inception and show that they perform as intended for daily holding periods. Leveraged ETFs are also successful in delivering the promised performance over holding periods of up to one week, their performance starts to deviate when the holding period increases to one month. Empirical evidence suggests that bear (short) ETFs deviate from their target return more quickly than their bull (long) counterparts as the holding period lengthens. A possible explanation for this is that transaction costs, which are related to daily re-balancing activity, are higher for bear funds. When comparing the daily performance of European vs American funds, the authors find them both to be equally efficient in replicating their benchmarks, although European leveraged ETFs are much smaller in their Assets Under Management (AUM) compared to US LETFs.

In recent years, especially as compared to mutual funds, exchange traded fund (ETF) markets have grown and advanced significantly compared to other financial asset classes because of relative advantages. We found that inclusion of real estate investment trusts (REITs) in ETF assets under management (AUM) positively impacts REIT capital structure (financial leverage), cost of equity capital, and stock market liquidity. As percentages of REIT outstanding shares included in ETF AUM increased, we found corresponding reductions in financial leverage (both book and market leverage), reduced costs of equity capital, and greater market liquidity. This should be of particular interest to REIT and ETF managers as well as REIT and ETF investors. Partially because regulatory statutes incentivize REITs to rely more heavily on external equity financing, REIT stocks included as ETF AUM showed greater reductions in leverage compared to non-REIT stocks also held as ETF AUM. Our results, including applying difference-in-differences models, were robust with respect to these findings, REIT type, and firm fixed effects.

Purpose – The purpose of this paper is to contribute to a better understanding of the impact of market liquidity on the daily tracking error of exchange-traded funds (ETFs). It puts a special focus on the liquidity cost of individual underlying stocks as well as the process of creation/redemption of ETF shares as key determinants of tracking ability. Design/methodology/approach – The study is based on daily observations of fund data for eight fully replicating German equity ETFs for July 2001-October 2013. A regression model with fund fixed effects is chosen to determine the effect of liquidity cost, creation/redemption and other control variables on daily tracking error. Data were compiled from issuer websites and Datastream. Proprietary XETRA Liquidity Measure, which was used as proxy for liquidity cost was supplied by Deutsche Börse. Findings – The study finds daily tracking error to significantly depend on the liquidity of underlying stocks. This finding emerges even though the ETFs in this study predominantly use in-kind creation/redemption. Even after controlling for creation/redemption, the liquidity impact remains basically unchanged. One reason might be imperfect replication of index weights: Either the in-kind-basket delivered in the course of creation/redemption does not perfectly match the benchmark-weights or the internal rebalancing of weights causes liquidity cost. Originality/value – To the best of the authors’ knowledge, this is the first paper that uses a specific liquidity measure for each single stock underlying an ETF. The findings extend the literature by corroborating the view that liquidity of individual stocks in the underlying portfolio has an impact on tracking error.

Exchange-traded funds (ETFs) can be a valuable component in any investor's portfolio, whether they are sophisticated institutional money managers or novice investors just starting out. Some investors make ETFs the sole focus of their portfolios, building a well-diversified portfolio with just a few ETFs. Others use ETFs to complement their existing portfolios, relying on them to implement sophisticated investment strategies. However, like any other investment vehicle, in order to truly benefit from ETFs, investors must understand and use them appropriately. It has been identified that Equity Exchange Traded Funds are riskier than Gold Exchange Traded Funds for both years. Among Equity Exchange Traded Funds, Bank-Equity Exchange Traded Funds exhibit less risk percentage change. It can be suggested that investors should avoid investing in any investment avenue, such as exchange-traded funds, that does not generate returns higher than the risk-free rate of return. It is important to analyse and assess the underlying asset of an exchange-traded fund before investing in it. Gold is considered a safe haven during economic crises, bringing stability to a portfolio during economic slowdowns and recessions. Exchange-traded funds represent a basket of securities traded on an exchange, much like stocks. They are listed on recognized stock exchanges, and their units are directly traded during regular trading hours. Exchange-traded funds have been developed to track various industrial sectors, investment styles, fixed income, global investments, commodities, and currencies