New Zealand exchange-traded funds (ETFs) are significantly less reliable trackers of the underlying indices than global peers, a recently-published study has found.
According to the study by Auckland University of Technology academics Jun Chen, Yi Chen, and Bart Frijns, the finding that the three NZX-based ETFs it analysed veered well off-benchmark compared to international products “should be of concern to investors”.
“Both at the daily and monthly frequencies, we observe significant differences between the ETF and its underlying index,” the research paper says. “The tracking errors of the ETFs are substantial, and larger than those of ETFs in other markets.”
The ‘Evaluating the Tracking Performance and Tracking Error of New Zealand Exchange Traded Funds’ report analysed the three NZX-owned Smartshares funds – the NZ Top 50 (FNZ), the NZ Top 10 (TNZ), and the NZ Mid Cap (MDZ) – over a 10-year period ending June 30 last year.
On average the study found the three ETFs displayed tracking errors of between 0.65-0.94 per cent, with the same statistic in the US ranging from 0.039 per cent to 0.11 per cent per year.
The paper cites other research showing “the tracking error of Australian ETFs is about 0.074% to 0.224% per month”.
“Investors should be concerned with the relatively large tracking errors as these can result in a performance of the ETF that deviates from index that the investor is seeking exposure to,” the study says.
The high degree of daily tracking error of the three Smartshares products under scrutiny also “suggests that these ETFs are not vehicles for very active trading”, according to the research paper.
Furthermore, the study found the more volatile the underlying index the greater the tracking error of the three Smartshares funds.
“This can be due either to increased difficulty or costs of matching the ETF with the underlying [index],” the report says.
Liquidity issues and “market microstructure noise” (such as the bid/ask ‘bounce’) could be partly to blame for the wayward nature of the three ETFs, the study says, with the results offering “some guidance on where improvements in terms of tracking performance and tracking error may be possible”.
Smartshares has already put some measures into place in an attempt to reduce tracking error,” the paper says. “Specifically, Smartshares, very recently, introduced dedicated market making in its ETFs to improve liquidity and decrease spreads.”
Published last December, the paper recently was listed on the new CFA Institute ‘Asia-Pacific Research Exchange’ (ARX) website.
Hong Kong-based Mary Leung, CFA head of standards and advocacy, showcased ARX at last week’s CFA Institute NZ fintech conference in Auckland.
ARX provides “like-minded investment management practitioners” access to research papers and the like “on industry topics and trends specific to the Asia-Pacific region”, according to its website. Despite its CFA origins, ARX is open to all, possibly less-educated, parties.