How to compare funds tracking the same index
Some exchange-traded funds (ETFs) that are tracking indices can sound really similar on paper. But what are these ETFs actually tracking, and how do people tell the difference between them and choose which one to invest in?
A quick intro to indices
An index measures the performance of a group of assets in a standardised way, and an index provider sets the rules for what investments are listed in an index. Some well-known indices include:
S&P 500 index, which includes 500 large US-listed companies
Dow Jones Industrial Average, which includes 30 large US-listed industrial companies
S&P/ASX 200 index, which includes 200 large ASX-listed companies.
However, indices can’t actually be invested in directly—they’re just a list. Instead, an ETF might try to match (or ‘track’) the performance of a specific index by investing in the things on that index.
For any one index, though, there might be a bunch of ETFs that are trying to track it. For example, the S&P 500 index is tracked by the Smartshares US 500 Fund, the Vanguard S&P 500 ETF, and many many others.
How do people decide between them? Well, let’s look at some ways to do homework on an ETF, and figure out if it’s right for your Portfolio.
First, gather info about the fund
To compare different ETFs tracking the same index, a good place to start is gathering some info about each fund. Dig into places like the fund manager’s website or the fund’s product disclosure statement (PDS).
Things to look at include:
The exchange the ETF is trading on—The exchange where the ETF is trading can impact things like the currency it’s trading in, market opening hours (when people can buy and sell), tax, and liquidity.
The ETF’s investment objective—What’s the ETF tracking, and what is it investing in? Does it invest in all the companies on an index equally, or are the investments allocated in a certain way? What is it trying to achieve?
Fees charged by the fund manager—Higher fees can cut into returns, and have a big impact on investment returns over the long term. One way to weigh up the cost of different ETFs is to compare expense ratios found in the fund’s prospectus or on websites like Yahoo Finance.
Who’s the fund manager?
As an investor, you might do your due diligence on the fund manager and ask:
Where is the fund manager based?
Are they well established and reputable?
Do they specialise in ETFs, or do they provide a range of investments?
What’s their track record? Have their funds historically done what they said they’d do? Noting that past performance isn’t a guarantee of future returns, but the info is available and worth considering.
How has the ETF performed?
Two ETFs tracking the same index can have different unit prices, but comparing these prices is generally less important than comparing their performances (or returns).
To dig into the performance of each fund, investors can look at:
Tracking—How closely has the ETF matched the performance of the index over time? Does this performance match the ETF’s investment objective?
Dividends—If dividends are important, investors might consider whether the ETF paid dividends in the past. How does the ETF’s gross dividend yield compare with other similar ETFs?
What are the risks?
Different ETFs will have different risks. Remember, risk isn’t always a bad thing—it’s about understanding what the risks are, how they fit with your risk profile, and how they can be managed. Australian ETFs issue a Target Market Determination document that describes the ETF characteristics and its fit for different investor types.
One of the key risks to consider is tracking risk (or tracking errors). This is when the performance of the ETF isn’t matching the performance of the index it’s tracking—and is therefore experiencing a lower rate of return. Tracking errors can be caused by things like:
the weighting of companies in the index changing, and the fund manager not being able to exactly match that change
foreign exchange fluctuations (if the ETF is in a different country to the index).
Some other risks to consider include:
Volatility—How frequently does the price of the ETF change, and by how much?
Currency—What currency is the ETF trading in, and is this different from your local currency? How might foreign exchange fees and rates impact returns? Is the ETF ‘hedged’ (protected from currency fluctuations), or ‘unhedged’ (exposed to currency fluctuations)?
Liquidity—How liquid has the ETF tended to be? The more liquid the ETF is, the faster and less expensive it is likely to be to convert an investment into cash.
Leverage—ETFs that are leveraged, use complex financial products (called derivatives) or borrow money to amplify the returns of the ETF. These have added risk in that if the index the ETF is tracking drops in value, the ETF will drop in value by an even greater amount, and can lead to significant losses.
Wrapping up
When it comes to comparing ETFs tracking the same index, there are lots of different things to consider. There’s no one-size-fits-all approach, so it’s all about doing your due diligence and considering what works best for you and your financial situation and goals.
Remember, past performance isn’t always going to be an accurate predictor of future performance.
Ok, now for the legal bit
Investing involves risk. You aren’t guaranteed to make money, and you might lose the money you start with. We don’t provide personalised advice or recommendations. Any information we provide is general only and current at the time written. You should consider seeking independent legal, financial, taxation or other advice when considering whether an investment is appropriate for your objectives, financial situation or needs.
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