ETF v praxi
How to Tell If Your ETF Is Lagging the Index — and What to Do About It
Key takeaways
- Tracking difference (TD) is the total deviation of a fund from its index over a year; tracking error (TE) measures the instability of that deviation.
- Negative TD means the fund beat its index — thanks to securities lending or dividend reinvestment.
- The TER alone does not tell the whole story; what matters is the fund's actual TD history.
- Check TD once a year by comparing fund and index performance over the same period.
- Large funds with active securities management tend to have lower TD than small passive funds.
Tracking difference (TD) is the numerical gap between an ETF's return and its benchmark index over a given period — and it is the most important figure for assessing a fund's quality.
TD vs. tracking error: what's what
Investors often confuse these two terms. Tracking difference answers: "By how much did the fund differ from the index over the year?" For example, −0.05% means the fund beat the index by five basis points. Tracking error measures the instability of this difference over time — how much the result fluctuates around the average. Low TE = a predictable fund.
Why a fund can beat the index
- Securities lending: the fund lends shares to short-sellers for a fee and returns the income to the fund.
- Dividend timing: for accumulating funds, dividends are reinvested immediately, whereas the index counts them only on the ex-dividend date.
- Sampling optimisation in funds that do not hold every constituent of the index.
Red flags: when lagging signals a problem
If TD consistently exceeds the TER (total expense ratio) by more than 0.1–0.2%, the fund is likely rebalancing poorly or incurring high internal transaction costs. Another warning sign is volatile TE — results swing from year to year without an obvious reason. For large funds tracking popular indices (S&P 500, MSCI World) TD is usually very close to zero or even negative.
How to check it in practice
Once a year — for example during your quarterly portfolio review — compare your ETF's total return (from your broker statement) with the index return over the same period. If your fund repeatedly lags by more than its TER, consider switching to a better provider. Switching has tax implications — especially if you have held the fund for less than 3 years and do not satisfy the holding-period test in the Czech Republic.
FAQ
What is tracking difference in an ETF?
The gap between an ETF's return and its index return over a year. A negative value means the fund beat the index. A positive value means it lagged. It is a more precise cost metric than the TER alone.
How do I check the tracking difference of my fund?
Compare fund performance over 1, 3, and 5 years with index performance on the issuer's website or justETF.com. The difference is your TD. Ideally you want a fund whose TD is zero or negative.
When is an ETF's underperformance of the index a problem?
When TD consistently exceeds the TER by more than 0.1–0.2% and tracking error is high (results vary year to year), the fund probably tracks the index poorly. For large funds on MSCI World or S&P 500 this is rare.