ETFs or Exchange Traded Funds are innovative products that provide exposure to its underlying asset. They generally track an index, a basket of securities, commodities or debt securities. As the name suggest, ETFs are traded on the exchange like a single stock. These funds are traded at real time price which is almost close to the net asset value (NAV) of the fund. Unlike listed close ended funds, which trade at substantial premiums or more frequently at discounts to NAV, ETFs are structured in a manner which allows to create new Units and Redeem outstanding Units directly with the fund, thereby ensuring that these funds trade close to their actual NAV. The value of the fund's underlying holdings at the end of the day determines the total net asset value of the fund. While these values are almost similar in most cases, you may at times find a minor difference between the NAV of the ETF and the price of the benchmark index. The performance of the Scheme may not be commensurate with the performance of the underlying index on any given day or over any given period. Such variations are commonly referred to as the tracking error.
If you are wondering what tracking error means and how it could impact your returns, keep reading. Here, we will cover the following points:
What are tracking errors?
In the world of ETFs, tracking errors refer to the difference between the actual returns of the fund and the returns of the benchmark index it has its underlying stocks in. If you are a beginner and want to try your luck in ETFs, you need to understand the meaning of tracking errors and their implications on your returns. Since these funds mirror the performance of the stocks on a particular index, the values of the fund and the index are almost the same. In some cases, you may spot some minor differences. While minor tracking errors might not impact your returns much, other factors may lead to the widening of the gap between these two values.
Reasons for Tracking Errors
Though an ETF mimics the performance of a benchmark index, why are there chances of tracking errors? Here are some of the common reasons for these errors:
Implication on Investments
Knowing the different reasons for tracking errors will help you watch out for ETFs endeavour to track their benchmark indices. The lower the tracking error, the more closely the ETF matches the benchmark. Under normal circumstances, such tracking errors are not expected to exceed 2% per annum. However, this may vary due to the reasons mentioned above or any other reasons that may arise and particularly when the markets are very volatile. The Investment Managers would monitor the tracking error of the ETF schemes on an on-going basis and would seek to minimize tracking error to the maximum extent possible. There can be no assurance or guarantee that the particular scheme will achieve any particular level of tracking error relative to performance of the Underlying Index.
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Visit www.icicipruamc.com/note to know more about the process to complete a one-time Know Your Customer (KYC) requirement to invest in Mutual Funds. Investors should only deal with registered Mutual Funds, details of which can be verified on the SEBI website (www.sebi.gov.in/intermediaries.html). For any queries, complaints & grievance redressal, investors may reach out to the AMCs and / or Investor Relations Officers. Additionally, investors may also lodge complaints on https://scores.gov.in if they are unsatisfied with the resolutions given by AMCs. SCORES portal facilitates you to lodge your complaint online with SEBI and subsequently view its status.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.