Abstract
This paper investigates the tracking performance of physical and synthetic equity exchange traded funds listed (ETFs) on the London Stock Exchange (LSE) during the period 2008 to 2013. We examine the ETFs accuracy in replicating their benchmark returns, with different geographical focus, applying several tracking metrics and including the financial crisis period. First, we did not find evidence that synthetic ETFs outperformed physical ETFs in terms of lower daily tracking performance. Second, the results show that the ability of ETFs to replicate its benchmark index’s returns depends on characteristics of the securities composing the index. Third, we provide evidence that the 2008-2009 financial crises had negative impact on daily tracking performance for all ETFs. Fourth, the method to estimate the tracking error impacts the results.
Highlights
Exchange-traded funds (ETFs) are considered a cost-efficient way to access a multiplicity of investment exposures and have increased popularity among investors after their first introduction on the New York Stock Exchange in 1993
This paper investigates the tracking performance of physical and synthetic equity exchange traded funds listed (ETFs) on the London Stock Exchange (LSE) during the period 2008 to 2013
The evidence shows that the ETFs with synthetic replication do not demonstrate better daily tracking performance relative to the ETFs with physical replication
Summary
Exchange-traded funds (ETFs) are considered a cost-efficient way to access a multiplicity of investment exposures and have increased popularity among investors after their first introduction on the New York Stock Exchange in 1993. There is basically to ways to measure the tracking performance of ETFs: tracking difference and tracking error. Empirical results indicate that tracking error is negatively associated to the fund’s expense ratio. Larger tracking error is produced by the fund with higher expense ratio. [4] point out that expense ratio has an impact only on tracking difference. Tracking error is not affected by expense ratio, because tracking error measures the volatility of the difference between the ETF’s and the benchmark index’s returns
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