This was brought home recently when I was doing some research on iShares exchange-traded funds (ETFs). Now, I don’t mean to single out iShares in this regard. In fact, I like their ETFs and use them in my portfolio. But I find one has to be careful when gathering information from their website.

For example, some of their ETFs are shown as having tracking errors less than their management expense ratios (MER). Of note, the iShares CDN Completion Index fund (XMD) is reported as having an annualized tracking error since inception of 0.44%, less than the MER of 0.55%.

This might be possible if the ETFs were based on “optimized portfolios” (i.e. use samples). But these cases are not. So, their tracking error should be larger since the MER is just one of its components.

It turns out that the ETFs’ underlying indexes were changed in recent years. So when one calculates an annualized tracking error since inception, it’s really an amalgam of two different indexes. That’s not of much use. At least there should be an warning asterisk?

Second, staying with tracking errors, the iShares CDN S&P 500 Currency-Hedged Index is shown as having an annualized tracking error of just over 1 per cent. However, as mentioned elsewhere, that figure is determined with reference to a currency-hedged version of the S&P 500 index. If the ETF is compared to the unhedged S&P 500 (which would be of more interest to many DIYers), the annual divergence averages more than 2 percentage points over the past three years.

A third challenge is trying to find out what the yield is on an ETF. This is not calculated on the site. What the visitor gets is the distribution history — so it is up to them to estimate a yield themselves. But using these tables can be a little tricky.

The novice might go to the table for 2008 and then pick the “total distribution for the year” to estimate the yield at current unit prices. But this total includes “Reinvested distributions per unit,” which is a distribution of capital gains at year end. This is a non-cash, irregular item (and doesn’t result in extra units as in the case of mutual funds). A better number to use for estimating the yield would seem to be the “cash distribution per unit” entry on the table.

This can be significant if the index basket has changed and the ETF manager had to sell and buy securities to keep up. See, for example, the iShares CDN Large Cap Index fund (XIU). Its total distribution in 2008 was $0.62 per unit, which at current prices would generate an estimated yield of 4%. But the reinvested distribution was $0.146 per unit, leaving a “cash distribution per unit” of $0.474. This generates a yield of 3.1%, a lot lower that the first estimate of 4%.

Analyzing trading data from the Australian stock market between 1990 and 2005, the paper finds that individual investors at discount brokers lose to institutional investors and individuals at non-discount (e.g. full-service) brokerages over nearly all trading periods. That is, their buys underperformed their sells, in contrast to institutionals and clients of full-service brokers.

One major reason for the underperformance was trading just after the exchange opened for business. Since institutionals and full-service clients have better access to research and other information sources, discount-broker clients trading just after the opening bell are operating with less information on overnight developments.

Another major reason is that discount-broker clients do not have the same facilities or time for monitoring their limit orders — so they may get “picked off.” They may, for example, put in an order to sell a stock at $30 when the price is $25, and if the price suddenly jumps to $40, investors more closely monitoring the market may pick off the investor with the limit order at $30 — and pocket the extra $10.

Who Win and Who Lose Among Individual Investors?
Kingsley Fong, David Gallagher and Adrian Lee
February, 2009