If mirroring the performance of an index is the ultimate measure of success for an exchange-traded fund, Vanguard’s Emerging Markets ETF (NYSEArca: VWO) has the upper hand on its direct, larger and more established competitor, iShares MSCI Emerging Markets Index Fund (NYSEArca: EEM).

Though both EEM and VWO track the same MSCI Emerging Markets Index, in 2009, the two have delivered very different returns.

Year-to-date, EEM has posted returns of 58.6 percent, trailing the index by 5.8 percentage points—a significant tracking error by industry standards. Meanwhile, VWO showed returns of 62.8 percent, only narrowly lagging the index, which has gained 64.5 percent in the period.

That gap may explain why VWO has attracted some $4.9 billion in new assets so far this year, while EEM has seen only $2.4 billion in new money head to its coffers.

What is driving the difference?

For starters, VWO uses what is called “full replication” to track its index, meaning it holds all the stocks in its index. EEM, by contrast, uses an “optimization” strategy, holding only a subset of those stocks, with the hope that that subset will reflect the index’s broader performance.

All in all, VWO has 790 stocks in its portfolio versus EEM’s 328.

But plenty of ETFs use optimization strategies, while still sticking close to the index. What gives with EEM?

According to Dina Ting, senior portfolio manager for Barclays Global Investors, EEM’s optimization strategy seeks to maximize liquidity and tax efficiency. For that reason, it relies heavily on the use of ADRs and GDRs to represent holdings in countries where restrictions and policies make it difficult to obtain exposure.

The use of ADRs and GDRs can change the daily returns of the fund versus its benchmark, since the ADRs and GDRs trade during U.S. market hours, while the fund tracks locally listed shares that may be closed during the U.S. market day.

“When you have a lot of ADRs and GDRs, you are going to see higher variances in the performance because of all the different time zones when trading takes place,” Ting said.

But time zone lags alone can’t explain a 5.8 percent performance gap. Another factor, according to Ting, is the massive size of the rally in emerging markets, with the index gaining 65 percent year-to-date.

“When you have a drastic move like that, you are going to see more variation between funds,” said Ting.

Ultimately, however, it comes down to the portfolio level, and the simple truth is that EEM’s portfolio differs substantially from both VWO and the index.

For instance, from a sector perspective, both funds held financial services at the top of their portfolios as of Sept. 30, with that sector hovering around 25 percent of the pie in both funds and the index.

But the weights in something like information technology varied widely: Info tech represented 16.09 percent of EEM’s exposure, compared with just 13.69 percent in the index and 13.63 percent in VWO.

You can see a breakdown of the two funds and the MSCI Index below:

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