- In a study published this week (“The Changing Face of Beta Investing: ETFs, Futures and Total Return Swaps”), Christos Costandinides and Deutsche Bank’s equity index and ETF research team highlighted the differences in performance between several European exchange-traded funds based on the same underlying index, the Euro Stoxx 50.
The snapshot provided by the bank of performance differentials between funds based on the most widely tracked broad equity benchmark is sufficient to make investors in “beta” products pause for thought. Aren’t these ETFs all supposed to be doing the same thing?
According to Deutsche Bank, the tracking difference between ETF and index, based on a sample of seven European providers, ranged from zero to 1.75% over a cumulative 20-month period from September 2008.
The chart, taken from the Deutsche Bank report, illustrates the post-fee performance of the ETFs included in the comparison. At around 1% per annum, the performance differential between the top- and bottom-performing funds (those from iShares and UBS, respectively) is significantly larger than the differences between the funds’ expense ratios: Deutsche Bank says that the average TER on Europe’s 34 ETFs tracking the Euro Stoxx 50 is 0.33%, within a range of 0 to 0.7%.
Incidentally, although Deutsche Bank cut the expense ratio on its own Euro Stoxx 50 ETF to zero last year, cheaper (or no!) fees haven’t pushed the db x-trackers fund to the top of the table. The db x-trackers Euro Stoxx 50 fund is in the middle of the range as far as post-fee performance is concerned, adding around 1% in total performance over the period when compared to its index benchmark.
Does this all suggest that investors should be looking at the comparative performance of different ETFs, rather than headline cost as expressed by the total expense ratio? Before attempting to answer that question, let’s look at what might be causing the performance of ETFs to diverge.
According to Costandinides and his colleagues, there are two primary reasons for what might at first glance look like “active” returns from what are notionally “passive” products. First, there are possibilities for tax efficiencies (some ETFs have more efficient tax treatment of dividends than the index calculators assume, while dividend reinvestment assumptions may also vary); second, securities lending can “top up” returns.
As it turns out, these two areas of performance “enhancements” are interrelated.
With regard to the taxation assumptions used by the index and the ETF, it’s worth noting that European exchange-traded funds typically use the “net total return” version of the Euro Stoxx 50 as their performance benchmark (Stoxx calculates three versions of of the Euro Stoxx 50: price only, total return net of tax, and gross total return).