ETF Tracking Error Explodes In 2009
According to a report from Morgan Stanley released in February, tracking error among ETFs widened significantly in 2009, as volatile markets, diversification requirements, optimization strategies and large movements in small-cap companies combined to cause many ETFs to miss their benchmarks.
Tracking error for U.S.-listed ETFs averaged a shocking 1.25 percent in 2009, up from 0.52 percent in 2008, Morgan Stanley said. On an asset-weighted basis, tracking error widened from 0.39 percent to 1.13 percent.
Morgan Stanley considers tracking error as any deviation (positive or negative) from the return of a fund’s benchmark index. Viewed through this lens, investors should always expect some tracking error in their funds, as the drag of expenses will cause most ETFs to lag their benchmarks over time.
In some areas of the market—such as U.S. major market and U.S. style funds—ETFs actually performed admirably, delivering tracking errors below their weighted average expense ratios. Currency funds and U.S. dividend products delivered similar results.
But in other areas, including U.S. sector and industry funds, global funds, commodity and fixed-income products, ETFs fell behind.
Fidelity’s Commission-Free Trading On 25 iShares
Fidelity Investments announced in early February that it will offer free trading on 25 widely held iShares ETFs, including some of the most popular ETFs in the world, such as the iShares S&P 500 ETF (NYSE Arca: IVV), iShares MSCI EAFE ETF (NYSE Arca: EFA) and iShares MSCI Emerging Markets ETF (NYSE Arca: EEM).
The brokerage giant said it has partnered with iShares sponsor BlackRock to offer free trades “for a period anticipated to be at least three years.”
The move came just months after Fidelity’s arch competitor, Charles Schwab, launched its own family of ETFs and offered Schwab brokerage customers the opportunity to trade those funds for free.
The Fidelity/BlackRock deal covers a much broader spectrum of ETFs, including ETFs covering most major equity and fixed-income categories. It covers 10 of the 25 largest ETFs in the U.S. and could help drive significant retail interest in ETFs. Commissions make retail strategies like dollar-cost-averaging unviable. By removing that barrier, brokerages like Schwab and Fidelity could help ETFs grab a larger share of the mutual fund marketplace.
Claymore Launches Wilshire Funds
Claymore Securities recently launched a trio of equity ETFs that track three separate broad-based Wilshire indexes. The move is an interesting one for Claymore, which has previously been known for its niche and sector ETFs rather than basic domestic building blocks.
The broadest of the three, the Wilshire 5000 Total Market Index ETF (NYSE Arca: WFVK), is based on the Wilshire 5000 Total Market Index. State Street Global Advisors offers the closest competing fund, the SPDR Dow Jones Total Market ETF (NYSE Arca: TMW). Until about a year ago, their two benchmarks were actually the same index, and only began to diverge with the termination of a joint venture agreement between Wilshire and Dow Jones in the spring of 2009. WFVK, however, charges just 0.12 percent in annual expenses, versus 0.21 percent for TMW.
The other two ETFs are the Wilshire 4500 Completion Index ETF (NYSE Arca: WXSP) and the Wilshire US Real Estate Investment Trust Index ETF (NYSE Arca: WREI). The funds charge expense ratios of 0.18 and 0.32 percent, respectively.
New Hedge Fund ETN Debuts
Credit Suisse joined the ranks of exchange-traded note providers in February, launching the Credit Suisse Long/Short Liquid Index ETN (NYSE Arca: CSLS). The note aims to deliver returns that “correlate to the historical performance of the Credit Suisse Tremont Long/Short Equity Hedge Fund Index.”
Like other hedge fund replication products, such as the IQ Hedge Multi-Strategy Tracker ETF (NYSE Arca: QAI), CSLS does not actually invest in any hedge funds. Rather, it aims to synthetically replicate the performance of the class of long/short hedge funds by taking quantitatively driven positions in various parts of the equity market: the S&P 500, Russell 2000, MSCI EAFE, Nasdaq-100 and MSCI Emerging Market Indexes, among others. Credit Suisse has said that it plans to launch more “alternative strategies” ETNs in the future.
Investors should note that CSLS comes with the complication of the note structure, which means that the value of the note is backed by the credit of Credit Suisse. On the upside, Credit Suisse does have a strong background in alternative beta strategies. Moreover, CSLS charges a surprisingly low fee of just 0.45 percent. Competing hedge fund ETFs typically charge 0.75 percent, plus fees for funds held in the underlying positions.
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