Learn more about your direct index tracking error

What is tracking error?

Tracking error is a measure of the difference between your portfolio’s performance and the benchmark index it’s tracking. It’s a helpful indicator of how well you’re performing to the investment you’re attempting to replicate.

What are the benchmarks that are used for my Frec index strategy? 

We provide you with an ETF benchmark that tracks the same or a similar index to the one your portfolio is tracking.

We offer 16 different index strategies and most of them have an ETF that also invests in that index and trades on a major US exchange. However, more specialized and international indices do not have ETFs that we can use that invest in the same exact index. Instead, we attempted to find an ETF that tracks similar investment exposure. Due to this, you may see a larger tracking error for those indices. Those indices are: 

• CRSP ISS US Large Cap ESG
• S&P Developed Markets ADR
• S&P Emerging Markets ADR
• S&P 500 Shariah
• S&P 500 Info tech (same holdings but slightly different methodology)

What are other reasons for larger tracking errors?

1. Customizations

If you make customizations to your portfolio you may have a larger tracking error. Customizations include actions such as adding or removing a stock, adding or removing a sector, or adjusting the weights of a stock or a sector within your portfolio. The same customization is not applied to your benchmarked ETF and therefore will result in a larger tracking error. Some errors may be large depending on the impact of the changes you made.

2. AUM fees and transaction costs

Frec charges an annual AUM fee that is billed on a monthly basis from your account. The ETF benchmarks have a similar, but in some cases not identical, expense ratio that is an annual fee that is deducted daily from the ETF’s assets. The timing and pricing difference between the two can create a larger tracking error. 

Additionally, there is a bid/ask spread and TAF and SEC fees associated with trading individual stocks within your direct index portfolio that can contribute to  tracking error. Based on research here, the impact is low at around 0.02%. 

3. Timing of dividend reinvestments

Typically ETFs pay out and reinvest dividends on a monthly or quarterly basis. While, Frec’s portfolio reinvests the underlying stock’s dividend immediately upon receipt. This difference can cause a larger tracking error. 

4. Corporate actions

There are positions within your index that undergo what’s called a corporate  action. You can learn more about corporate actions here. The differences in  handling of the stock changes by your portfolio and the underlying ETF can also  lead to a larger tracking error. 

Where can I view my tracking error?

You can view your tracking error on your direct index details page on your performance graph. Make sure that “Compare to ETF” is selected, and then hover or tap on the graph to see your direct index tracking error against the benchmark ETF. You can also adjust your tracking preferences in your direct index settings. Learn more about tracking preference here.