Replication quality is critical to you as an investor, yet it is not a trivial matter. Our research led us to a few metrics that should be taken into account when choosing between two or more ETFs.
Recognized by most of the industry, we advocate the use of the Tracking Difference and the Tracking Error when comparing ETFs. From our glossary, you can read:
Tracking Difference: The difference between the ETF annualized performance based on the official Net Asset Value (NAV) and the official replicated index annualized performance, over the given period.
This gives the full picture on long-term deviation from the benchmark, which you should want to minimize. Yet, day-to-day replication quality is not captured by this metric; you also want look at the Tracking Error:
Tracking Error: This indicator of relative risk corresponds to the annualized volatility of the daily return difference between the ETF and its corresponding tracked index over the given period. The volatility is annualized using a 260 days basis (daily volatility multiplied by the square root of 260).
The idea is that these 2 measures rely on each other: a low Tracking Error gives you confidence on the Tracking Difference; but if the Tracking Difference is poor, a low Tracking Error only indicates that it is poor in a reliable way.
This complementarity is really the core of our approach.
Based on this, and in order to streamline the selection process, we put together a quantitative rating methodology for ETFs, which let us assign 0 to 5 stars, accessible to anyone registered (even if not on a paying plan).
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Never hesitate to give us feedback or ask us questions; we think ETFs are a promising approach to passive investing, and we’re on a mission to help investors navigate the ETF market confidently.