Abstract

This research focuses on the differences between synthetic and traditional exchange-traded funds in benchmark replication process. It extends previous literature by empirical examining the tracking ability of traditional and synthetic ETFs traded at the Swiss Stock Exchange offered by the leading providers in Europe. 35 equity ETFs are used in the sample. For both types of funds the average tracking error is estimated in four ways. The research demonstrates that both traditional and synthetic ETFs have significant tracking errors. The findings also show that, contrary to popular opinion, synthetic ETFs have higher tracking errors than physical. These facts are of a significant importance to private investors and portfolio managers, especially if the performance of portfolio manager is based on a comparison to the performance of a benchmark.

Additionally, factors that influence tracking errors are estimated. The results suggest that tracking errors are influenced by expense ratio, number of securities in the benchmark and type of replication for all estimation methods. Average daily trading volume doesn’t influence dependent variables except for one tracking error estimation method.

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