I often visit the website IndexUniverse.com, which as you can imagine has a focus on the world of indexed investments. But even though indexers are known more for their appreciation of science, facts and figures, the writers at IndexUniverse.com are really entertaining. Matt Hougan recently wrote a post titled Index Funds Behaving Badly. Here are some highlights from the article:
The highest annual expense ratio for an index mutual fund in 2008: 5.49%
Largest tracking error for an ETF in 2008: 11.9%
The post is designed to highlight some of the not-so-flattering points about indexing. Of course, with billions of dollars flowing into index funds and ETFs, it should come as no surprise that many product manufacturers are taking bad ideas from other areas of the industry to capitalize on where the money is flowing. It’s good for shareholders, but bad for investors. (The ultimate conflict? For more discussion on this, see the post on Vanguard. Vanguard is owned by it’s clients.)
I don’t suppose that the tracking error was 11.9% to the up side :-)
A category with 20 – 30 stocks should not be called an index. There is usually a very subjective way of selecting those stocks. I think Vanguard’s framing of “closet active management” applies to these narrow categories.