Tracking difference: how closely an ETF follows its index
An index ETF sets out to copy an index. In practice it lands a hair above or below. That small gap has a name: tracking difference.
Copying an index is harder than it sounds
An The published list of investments (the “index”) the fund aims to copy, such as the MSCI World. More → is just a published list — say, the 1,500 companies in a world index. An ETF tries to hold that list so its value moves in step. But a few things get in the way every year, so the fund’s return ends up a little above or below the index. Measured over a period, that gap is the tracking difference.
What nudges the fund off the index
The main ones: the The yearly running cost of the fund, shown as a % of your money. €0.20 per €100 a year at 0.20%. Lower is cheaper. More → is skimmed off, dragging the fund slightly below the index; tax on the dividends the fund receives can cost a little; and how the fund holds the shares — full How the fund copies its index: by buying the shares directly (physical) or using a swap contract (synthetic). More → versus a representative sample — changes how tightly it hugs the list. Some funds also earn a little back by lending out shares, which can push them the other way.
How to read it
A fund’s factsheet usually shows its tracking difference over recent years. For a plain index ETF, an index investor is typically looking for a gap that is small and steady — close to the fund’s fee and not jumping around. A large or erratic gap is a prompt to ask why, not a verdict on its own. And past tracking, like past returns, does not promise the future.