Are Index Funds with Lower Tracking Errors Better for Post-Tax Returns?
When it comes to index funds, tracking errors are often seen as a negative. But what if there’s more to it? Could a fund manager intentionally allow tracking error to avoid taxable events, ultimately boosting post-tax performance?
To investigate this, we analyzed data from various index mutual funds across different asset categories. The results may surprise you.
For large-cap equity, emerging market, and fixed-income funds, those with higher tracking errors actually showed better post-tax performance than their low-error peers.
However, in small-cap, value, and growth funds, low tracking errors appeared to be associated with better post-tax performance. The numbers speak for themselves.
Overall, our study suggests that tracking errors may not always indicate fund quality. While lower errors can be beneficial for some asset classes, higher errors could be a strategic move to maximize post-tax returns.
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Disclaimer: The views expressed are solely those of the author and do not constitute investment advice. CFA Institute and the author’s employer may have different perspectives.
Image credit: ©Getty Images / matejmo
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