Is your ETF investment measuring up to your expectations? A big part of investigating investment performance is knowing what you are looking for. In most cases, it’s total return, which you calculate by adding any change — up or down — in share price to any dividends or interest the investment paid.

If you divide the total return by the amount you invested in the fund, the result is a percent return. You can use this figure to compare the results for one investment to that of similar investments and also to the appropriate benchmark.

Monitoring the performance of your core ETF holdings is relatively easy. You can find percent return over various time periods, online at the fund sponsor’s website, on financial sites, and through rating services. Return results for various time periods, from one day to three years or as long as a particular ETF has been operating, are computed using information the sponsor provides. Results for longer than a year are annualized to provide a per-year basis.

Remember, though, that your actual return, whether realized or not, may be different from what’s reported based on fund statistics. Among the reasons are the timing of purchase and sale of shares and the amount of commission you paid, if any.

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In addition, the newer an ETF is, the less informative its performance record will be. Unless a fund has been in operation through a full market cycle of gains and losses, you can’t evaluate whether it has been more or less volatile than the market as a whole or, in the case of a narrowly focused ETF, than its sector of the market.

Performance factors

An ETF’s performance is based primarily on what is happening with its underlying investments as reflected in the ETF’s index. For instance, the return on the SPDR that tracks the stocks in the capitalization-weighted S&P 500 can be expected to reflect the changing value of that index. A commodity ETF tracks what’s happening with that underlying commodity as reflected in the changing value of futures contracts — increasing in value when the price of the commodity increases and dropping if the commodity loses value.

But the underlying investments don’t tell the entire story. The fund expenses and management practices, such as how quickly a stock ETF reinvests cash dividends and capital gains, can mean an ETF’s return varies from the return of the index it aims to duplicate.

ENHANCED ERRORS

Enhanced ETFs, whose sponsors seek to outperform the market by using indexes that include only the strongest performing securities within a market segment rather than its entire universe, may run the risk of greater losses in a falling market because their underlying indexes are more volatile than those that are passively managed.

This gap is called a tracking error. The smaller the negative tracking error — the amount by which an ETF’s return trails that of the index — the happier investors and fund sponsors are. To help ensure that the negative tracking error on the funds you buy is minimal, you should compare fees and expenses for different ETFs tracking similar segments of the market. You can get a snapshot of comparative costs by looking at each fund’s expense ratio, which is the percentage of your fund assets you pay each year in administrative and investment expenses.

You will also want to investigate any other factors that can impact return. For instance, an ETF that tracks an index whose components change frequently may have a higher tracking error because its transaction costs – which aren’t included in the expense ratio — are higher.

Top ETFs performance trackers

You can find ETF performance information online at these and other sources:

  • ETF Database provides daily coverage of ETFs, an extensive database of ETFs traded in the United States, a free screener of the ETFs in that database, and a variety of other tools including an analyzer to compare ETFs and a mutual fund to ETF converter.
  • Morningstar has a full range of information about ETFs, including an ETF screener. While some information is free, an in-depth research is available only to paid members.

Risk and return

The return an ETF provides is directly related to the risk it carries, a relationship that’s characteristic of every investment you make. Investments with the highest potential return invariably expose you to the greatest investment risk. Certain risks are predictable. Markets, and the ETFs invested in them, move through recurring patterns of ups and downs. Because the nature of those cycles is predictable even though their timing isn’t, you can both benefit from and help offset their impact by investing across a variety of asset classes and subclasses – something that ETFs make easy.

By investing in diversified ETFs, you can also reduce the impact of the unexpected risks that may be posed by individual corporations: management risk and credit risk, for example. And by adding ETFs that track narrower indexes or alternative investments, you can add the potential to capitalize on above-average returns in the short term without having to select individual investments within a specific sector. What you don’t want to do, however, is invest in any ETF without fully understanding the risks to which it could expose you.

Tracking ETF Performance by Inna Rosputnia

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