What causes an ETF to differ from the index?

  • Last Updated:
  • Nov 26th, 2017 8:20 pm
Jr. Member
Oct 29, 2017
115 posts

What causes an ETF to differ from the index?

ETFs try and follow their underlying index but I know fees can cause a drag on return so that the performance of an ETF does not completely follow the index.

That being said, according to MorningStar, VAB has a 5 year return of 2.83% and the Canadian Fixed Income (NAV) is at 2.36% - see ... ture=en-CA

That is almost a half percent difference. Isn't that a significant deviation?
4 replies
Deal Addict
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Feb 1, 2012
1225 posts
Thunder Bay, ON
Very observant. There are lots of finicky details in investing. I believe slightly different indices are responsible for the difference.

Note that VAB's index is the Bloomberg Barclays Global Aggregate Canadian Float Adjusted Bond Index ... m#barclays

If you look at VAB's performance vs its benchmark on the Vanguard Canada website the 5 yr VAB performance is 2.76 vs 2.94 for the benchmark. So the fund trails its benchmark by .18%, of which the MER accounts for .13%. The difference could be cash drag, or maybe the MER has declined over time. Almost all ETFs will slightly trail their benchmarks. ... erformance

The Morningstar Canadian Fixed Income index is not exactly the same. It's performance is based on:
This is a proprietary index developed by Morningstar Canada based on the CIFSC Fund categories.
This index includes funds which meet the following criteria:
"Funds in the Canadian Fixed Income category must invest at least 90% of their fixed income holdings in Canadian dollars with an average duration greater than 3.5 years and less than 9.0 years. In addition, these funds must invest primarily in investment-grade fixed-income securities, such that the average credit quality of the portfolio as a whole is investment grade (BBB or equivalent rating or higher) and not more than 25% of the portfolio's holdings are invested in high yield fixed income securities. For purposes of the category definition, up to 30% of a Fund's assets may be held in Foreign Fixed Income products which will be treated as Canadian content provided that the currency exposure on those holdings is hedged into Canadian Dollars."
So Morningstar is not comparing directly to the same index that VAB tries to track. Note that VAB's index exceeds the Morningstar benchmark by about 0.5%. Just a guess but I would attribute that to different duration of the indices. Morningstar's benchmark says "least 90% of their fixed income holdings in Canadian dollars with an average duration greater than 3.5 years and less than 9.0 years.". Whereas VAB has >30% of its holdings with duration >10 years. So VAB's duration is longer than the Morningstar fixed income benchmark, which drives higher returns in general, and especially when rates are dropping.

It's good to understand what you are investing in, and the impact on performance and risk. Good sleuthing! It's easy to get caught up in the details though. Staying invested long-term in an asset allocation aligned with your risk tolerance is probably the most important ingredient in investing success. The search for the perfect portfolio is the enemy of a good portfolio that you can invest in and profit from.
I solemnly swear, to never assume I have an inkling at which direction the market will head, and to never make any investments based on a timing strategy.
Deal Fanatic
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Jun 19, 2009
5912 posts
Also most funds try to mirror the index but in the interest of saving money, they sometimes do representative sampling of the index to get 99%+ representation of the index as it wouldn't be cost effective to obtain 100% mirroring due to low liquidity of certain stocks, commissions, trading costs etc.