DIY Investor Magazine
| Oct 2017
20
AVOIDING ETF PERFORMANCE PITFALLS
Dominique Riedl
CEO, justETF
Measuring performance should be simple but the same
investment can look quite different if you check it on
different websites. To make sure you’re not caught out,
we explain the main performance pitfalls so that you
know you’re always comparing like for like.
The major factors that can alter an ETF’s return or
performance calculation include:
•
How distributions are treated
•
What time of day the price was taken
•
Subtle variations in time periods e.g.
the definition of a year
•
Which currency is being used
•
Currency conversion methodology
Small differences in these factors can cause large
discrepancies in the performance of an ETF. It can be
like comparing the speed of Formula One cars without
knowing which are being clocked in miles per hour and
which are using kilometres per hour.
So let’s take each factor in turn and show you what to
look out for.
PERFORMANCE TREATMENT OF DISTRIBUTIONS:
ADDITION VS. REINVESTMENT
It can be difficult to compare the returns of a distributing
ETF versus an accumulating (or capitalising) one.
A distributing ETF pays out all dividends or interest
while an accumulating ETF reinvests that income back
into the fund - so the investor automatically benefits
from compounding returns (you earn interest on your
interest).
Without an adjustment, an accumulating ETF will appear
to grow faster than a distributing ETF that doesn’t
reinvest income.
The most common method of ensuring a fair
comparison is to assume all distributions are reinvested
back into the ETF.
This way you can compare the growth of both types
of ETF on a total return basis: including any capital
appreciation plus the compounding effect of income
being invested in new shares of the fund.
justETF uses the reinvestment method and assumes
that all distributions are rolled back up into the ETF on
the ex-dividend date.
WHAT IS THE EX-DIVIDEND DATE?
The price of an ETF is reduced by the amount of its
forthcoming distribution on the ex-dividend date; this
is to ensure a fair price for investors who won’t qualify
to receive the dividend if they buy into the ETF on or
after the ex-dividend date. A seller doesn’t receive the
dividend either if they sell before the ex-dividend date.
The distribution is actually paid on the payment date.
This date will usually occur several days, or occasionally
a few weeks, after the ex-dividend date.
An alternative method is to add the value of the
distributions to an ETF’s price instead of reinvesting
them. Distributions treated this way don’t count
as producing further income and so the powerful
compound effect is sheared off from the ETF’s track
record.
This can lead to a wide performance gap over time
between the two methods, especially in growing
markets.
