Tracking efficiency of European ETFs replicating performance of EUROSTOXX50 index

Recently the growth of passively managed investment funds has been substantial all over the world, especially in the United States and in the European countries. Last year, we witnessed the increased popularity of new index-linked financial products like exchange-traded funds (ETFs) and other exchange-traded products (ETPs) and the availability of new financial market indices. While the main aim of ETFs is to replicate as closely as possible both the returns and risks of the underlying index, tracking error (TE) in performance is inevitable.

The main objective of the article is to analyze the replication quality of ETFs listed on major European stock exchanges against the benchmark – EUROSTOXX50 index. Tracking difference (TD) and TE, two mostly followed metrics, have been used to measure their tracking efficiency. The calculations were made for the 2012-2017 period using different TE calculation techniques and different return intervals – daily, weekly and monthly. Data come from two sources Thomson Reuters EIKON database and selected ETF webpages containing key investors information. The article explores a few selected factors, that drive the performance of ETFs away from their target indices.

The study reveals that European ETFs have been able to closely track the underlying index, but to varying degrees. The article identifies a number of factors that are important determinants of tracking error for ETFs replicating the return of the EUROSTOXX50 index. The results will have important implications both for investors investing in European blue-chips and asset managers offering passively managed products with an exposition on large-cap stocks from the Euro area.