Why & how do ETFs track an index?

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This article explains why ETFs track an index and whether more than one ETF can track the same index in Australia.

Money Question Received

Can two ETF providers/managers have ETFs that track the same index?

Read previous questions in our Money Q&A Library and submit your own on the Rask Education homepage!

Kate’s Response

If you’ve started researching Exchange Traded Funds (ETFs) you may have come across the terminology ‘this ETF aims to track the performance of an index…’ or ‘seeks to track the return of…’, or the works ‘benchmark’ or ‘index’ in the FAQ/facts section.

This tells you which index the ETF manager has selected for the fund to track — as there are a variety of companies that operate indices for ETFs to track. For example, an ETF that “aims to track the performance of the ASX 200 index” will buy all of the shares included in the ASX 200. Read our tutorial: “What is the ASX 200?

Why do ETFs track an index?

The index selected for an ETF provides you, the investor/customer, with an indication as to what the purpose of the ETF actually is. 

Related tutorial: What Is An Index Fund?

Once you know what the index is (and which asset class it is invested in) you are then able to compare the ETF’s historical performance to the performance of its selected index, to observe whether the ETF is meeting its objectives or not.

Before the ASX allows an ETF to track the benchmark/index of its choice, ASIC (the regulator) says the benchmark provider must meet internationally recognised principles concerning governance, quality of the benchmark and its methodology, as well as accountability.

Australian index example

One example of an index in Australia is the S&P/ASX 200, an Australian stock market index. This index is created and maintained by Standard & Poor’s (S&P). It tracks the value of the 200 largest public companies listed on the Australian Securities Exchange (ASX), ranked by their market capitalisation.

Related tutorial: Why Is The All Ordinaries and ASX 200 In Points And Not Dollars($)?

Can two ETFs track the same index? 

There is no reason that two ETFs can’t track the same index, and there are some larger and more popular indices where this is quite common. However, sometimes, an ETF provider might try to get ‘exclusive rights’ over that index.

Benchmarks are created and operated/maintained by companies like MSCI, S&P, FTSE, Moody’s, etc. They are then licensed to ETF managers to track. For the benchmark provider, it makes sense for them to sell the right to track their index to more than one customer.

At the time of writing, there are 10 ETFs operating globally that track the S&P/ASX 200 index, which is operated by S&P Dow Jones Indices.

I have also seen niche ETF operators pay a benchmark provider to create a new benchmark that tracks investments within a specific set of parameters, and in this situation that ETF may be the only one tracking its index. This is common when an ETF provider wants to do what their competitor is doing — but the first choice index might be protected.

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Kate Campbell @ Rask

Kate Campbell @ Rask

Kate Campbell is the co-host of The Australian Finance Podcast with Owen.

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