A Fin24 user is puzzled over the difference between the performance of an exchange-traded fund (ETF) and the index it tracks. He writes:
Why is it that the performance of an index-tracking ETF such as Satrix Divi differs from the the index it tracks (Dividend + Index) before fees and charges?
While they do trend in a similar pattern, they react differently despite the same weighted holdings.
Also, are the dividends announced by the index indicative of the dividends to be announced by the ETF?Brett Landman, CEO of Satrix Managers, responds:
The investment objective of each of the Satrix ETFs is to replicate, as closely as possible, the price and yield performance of the relevant index. It does this by holding a portfolio of securities substantially equivalent to the basket of securities comprising the index, and in the same weighting.
The Satrix portfolios will be adjusted as determined by the ground rules to conform to changes in the basket of securities comprising the index. This ensures that the composition and weighting of the securities comprising the relevant Satrix portfolio at all times substantially reflect the composition and weighting of the securities in the index.
A Satrix portfolio’s ability to replicate the price and yield performance of the index will be affected by the costs and expenses incurred by the portfolio in question.
Costs and expenses will accordingly result in the index not being replicated perfectly by the portfolio, as is acknowledged by the user in his query.
In addition to “mistracking” of the index caused by costs and expenses incurred by the portfolio (which are obviously not applicable to an index), the timing difference of the reinvestment of dividends between the index and the ETF portfolio can explain why the ETF is not perfectly tracking the index (even if costs and expenses are disregarded).
In the case of a total return index (which I assume the user is referring to), as and when dividends are declared by the constituent companies comprising the index, these dividends are reinvested on ex date (determined with reference to the company declaring the dividend).
In this regard it is important to note that in reality there is also a timing difference between ex date and the receipt of dividends (payment date).
In the case of an ETF, using Satrix Divi as example (which makes quarterly distributions to investors), the dividends declared by the constituent companies are accrued (and held in cash when received on payment) in the portfolio until quarter end.
A distribution is then made to investors (together with other accrued income, such as interest earned over the applicable quarter).
These quarterly distributions are made to investors net of costs. When calculating the total return performance of the Satrix Divi (price performance with distributions reinvested), the calculation methodology applicable to the industry reinvests the distributions declared (and paid to investors) by the ETF on ex date of the ETF security.
Accordingly, it is evident from the different treatment of the reinvestment of the dividends in the case of an index, and the quarterly distributions in the case of the Satrix Divi (as an example), that there are timing differences.
These timing differences - which result in the investment of dividends in the case of an index being “invested” in the market earlier than the reinvestment of the quarterly distributions paid by the Satrix Divi ETF - further explain the slightly different performance between the index and the ETF (the extent of which is determined by prevailing market conditions).
Lastly, with regards to the user’s query whether dividends announced by the index are indicative of the dividends to be announced by the ETF, please note that indices do not declare or announce dividends.
A total return index (an index being a statistical measure of change or TRI) measures the total return, combining both capital performance and reinvested income.
As stated in the response above, in calculating the TRI dividends declared by the constituent companies are “reinvested” on ex date.
It is, howeve,r possible to use the total dividends declared by the constituent companies in the index - and therefore the ETF portfolio - over any applicable quarter as a indication of the amount of the quarterly distribution to be declared by the ETF gross of costs; in other words, before the deduction of costs and expenses that will reduce the actual amount of the quarterly distributions declared and paid by the ETF.
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