Grab that number for today, then go back to yesterday and get the same one-year numbers. Keep doing that until you have a year’s worth of rolling returns, based on two years of data. Here’s what you get for these two funds:

When we first started doing these calculations and presenting them to folks a few years ago, we made the point of calling this “Tracking Difference” to separate it from academic tracking error. We got a lot of funny looks, but recently the Investment Company Institute adopted precisely the same language, so we think it’s sticking now.

And what does it tell us? It tells us that your expectation for any given year should be that VWO trails its index by about its expense ratio (26 basis points vs. a 22 basis point expense ratio). EEM will meanwhile actually beat its own expense ratio, trailing the index by just 0.48 percent, which is likely due to good securities lending.

However, with EEM, your range of expected outcomes is much, much wider, from trailing the index by 1.22 percent to beating the index by 0.52 percent. That’s a pretty wide range of outcomes.

So purely from the “tracking” perspective, VWO gets the nod here, exactly the opposite of what that “tracking error” statistic shows.

So where does that big number come from? Accounting issues. Vanguard, like quite a few ETF issuers, chooses to publish a “fair value” net asset value (NAV). That means instead of taking the price of some South Korean company after markets closed there, you adjust the price of that company based on certain proxies such as how the currency has moved, how futures have traded, and so on.

It’s essentially what the market does all day with VWO—after all, it will trade up or down even though most of its constituents are closed for trading. It’s not right or wrong—it’s a fund accounting choice, designed to get the NAV of the fund closer to reality.

EEM makes a different choice—to publish a NAV more aligned with how the index provider determines the level of the index. So on any individual day, EEM will report a NAV that’s much more closely tied to the reported change in the MSCI Emerging Markets Index.

These kind of accounting issues pop up all over the ETF landscape. Many international indexes mark all currency conversions at 4 p.m. GMT. Funds that track those indexes often mark their currency conversions at 4 p.m. Eastern time. If the currency moves a lot in the intervening five hours, you can get wild swings in perceived “tracking.”

In the bond markets, index providers and issuers can use different pricing services, leading to apparent tracking differences even if the fund holds precisely the same portfolio as the index.

The moral of the story is simple: Always consider your investments from your actual holding expectations, not just a surface statistic.

At the time this article was written, the author had no positions in the securities mentioned. Contact Dave Nadig at dnadig@indexuniverse.com.

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