PT - JOURNAL ARTICLE AU - Dominic Maister AU - Mitchell Schorr AU - David Perlman TI - ETFs: <em>Average Tracking Error Was Well Contained in 2008</em> DP - 2009 Sep 21 TA - ETFs and Indexing PG - 108--125 VI - 2009 IP - 1 4099 - http://guides.pm-research.com/content/2009/1/108.short 4100 - http://guides.pm-research.com/content/2009/1/108.full AB - Tracking error may be a concern to ETF investors, as the funds are designed with the objective of providing access to and replicating the performance of a specific index. Despite extreme volatility in 2008, tracking error, which the authors define as the difference in total return between an ETF’s net asset value and its underlying index, was generally well contained. The most common sources of tracking error include fees and expenses, portfolio optimization, and index turnover. However, compliance with SEC diversification requirements can lead to extreme tracking error for select ETFs, as they may be forced into material holding and weighting deviations from stated benchmarks. While many newer ETFs based on alternative weighting methodologies (including modified cap-weightings) are able to reduce optimization and mitigate tracking error, investors should consider the potential for wider performance disparities between these ETFs’ benchmarks and more established indices.