@article {Rowley35, author = {James J. Rowley, Jr and David T. Kwon}, title = {The Ins and Outs of Index Tracking}, volume = {41}, number = {3}, pages = {35--45}, year = {2015}, doi = {10.3905/jpm.2015.41.3.035}, publisher = {Institutional Investor Journals Umbrella}, abstract = {The extent to which an index fund successfully tracks its benchmark index is gauged by two metrics: excess return and tracking error. Using a cross-sectional sample of 198 U.S.-domiciled, index exchange-traded funds (ETFs) covering 921 annual observations, the authors analyze the effect of several input variables on index funds{\textquoteright} excess return and tracking error. Because the sample consists of ETFs, we conduct the analysis on the basis of both net asset value (NAV) and market price. They find that a fund{\textquoteright}s expense ratio is the dominant variable that has a significant{\textemdash}and negative{\textemdash}effect on excess return. With respect to NAV-based tracking error, they report that higher active-share levels and the existence of fair-value pricing increased tracking error. Surprisingly, the authors also find that higher expense ratios were associated with higher levels of tracking error. Finally, on a market-price basis, the effects of fair-value pricing on tracking error were greatly reduced.TOPICS: Mutual funds/passive investing/indexing, portfolio management/multi-asset allocation}, issn = {0095-4918}, URL = {https://jpm.pm-research.com/content/41/3/35}, eprint = {https://jpm.pm-research.com/content/41/3/35.full.pdf}, journal = {The Journal of Portfolio Management} }