How can some ETFs beat their benchmark? (2024)

FAQs

What is the benchmark of an ETF? ›

Using a benchmark helps determine how your investments are performing on a relative basis, either on the portfolio level or the individual holding level. The benchmark for an ETF depends on what index or sector it tracks. Passive ETFs aim to mimic the benchmark's performance, while active ETFs try to beat it.

Morningstar calculated how many of the funds and ETFs in 2023 were able to beat their benchmarks over increasingly long trailing periods; those findings are summarized in the chart above. Over the 20-year performance horizon, the success rate is as low as 5%.

Long-term investors have been well served by index funds, which often charge very low fees and can be hard for active portfolio managers to beat. But some investors want to select individual stocks for portions of their portfolios.

A favored measure is tracking difference—a statistic that looks at how far an ETF has lagged its benchmark, on average, over a one-year period. Tracking difference incorporates the effects of an entire range of management decisions, from securities lending to optimization decisions.

Unambiguous and transparent – The names and weights of securities that constitute a benchmark should be clearly defined. Investable – The benchmark should contain securities that an investor can purchase in the market or easily replicate. Priced daily – The benchmark's return should be calculated regularly.

A benchmark is a standard or measure that can be used to analyze the allocation, risk, and return of a given portfolio. A variety of benchmarks can also be used to understand how a portfolio is performing against various market segments. The S&P 500 index is often used as a benchmark for equities.

And there's one ETF that specializes in those stocks. That's the Invesco S&P 500 GARP ETF (NYSEMKT: SPGP), which has beaten the S&P 500 in seven of the last 10 years and has steadily outperformed it over the last decade, as you can see from the chart below.

It beat 88 of large-cap mutual funds over the past 10 years. And there's good reason to expect it to remain consistently better than nearly every fund out there. The ETF that consistently outperforms nearly 88% of mutual funds is the Vanguard S&P 500 ETF (VOO -0.74%).

A history of outperformance

The Invesco QQQ Trust (NASDAQ: QQQ) has produced a total return of 460% in the past 10 years, easily crushing the S&P 500's gain.

That makes outperforming the S&P 500 on a consistent basis no small task. The one fund that has beaten the index in nine of the past 10 years is the Technology Select Sector SPDR Fund (NYSEMKT: XLK).

Has anyone ever lost money on index funds? ›

All investments carry risk. An index fund, like anything else, can potentially lose value over time. That being said, most mainstream index funds are generally considered a conservative way to invest in equities (although there are lesser-known index funds that are thought to carry greater risk).

Study after study shows that it's really tough to outperform index funds over the long-term after accounting for fees. Those that manage to beat the market usually do so by taking on more risk (via leverage or other means) or get lucky with the equivalent of 10 consecutive heads in a coin-flipping contest.

ETFs track a benchmark index by holding all the securities in the index. To closely replicate the performance of the index, the ETF will hold the securities in equal proportion to their weighting in the index.

Compare the ETF's Market Price to the NAV

Compare the market price to the NAV to determine if the ETF is trading at a premium or discount to its NAV. If the market price is higher than the NAV, the ETF is trading at a premium. If the NAV is lower than the price, the ETF is trading at a discount.

Fund management and trading fees are often cited as the largest contributor to tracking error. It is easy to see that even if a given fund tracks the index perfectly, it will still underperform that index by the amount of the fees that are deducted from a fund's returns.

The S&P 500 is largely considered an essential benchmark index for the U.S. stock market. Composed of 500 large-cap companies across a breadth of industry sectors, the index captures the pulse of the American corporate economy.

It's basically an indication of the fair value of a single share of the fund. It provides investors a reference point around which they can gauge any offers to buy or sell shares of the fund.

Each ETF is rated relative to others in its category using six different metrics, including liquidity, expenses, performance, volatility, dividend and concentration.

A benchmark index is a reference point used to compare the performance of a mutual fund. It is essentially a basket of securities that represents a particular market segment, like large-cap stocks.