Can an ETF perform differently than its holdings?
The Creation/Redemption mechanism is how shares of an ETF are created or redeemed as needed and thus is where there can be differences in what the value of the holdings can be versus the trading price. If the ETF is thinly traded, then the difference could be big as more volume would be where the mechanism could kick in as generally there are blocks required so the mechanism usually created or redeemed in lots of 50,000 shares I believe. From the link where AP=Authorized Participant: With ETFs, APs do most of the buying and selling. When APs sense   demand for additional shares of an ETF—which manifests itself when the   ETF share price trades at a premium to its NAV—they go into the market   and create new shares. When the APs sense demand from investors   looking to redeem—which manifests itself when the ETF share price   trades at a discount—they process redemptions. So, suppose the NAV of the ETF is $20/share and the trading price is $30/share. The AP can buy the underlying securities for $20/share in a bulk order that equates to 50,000 shares of the ETF and exchange the underlying shares for new shares in the ETF. Then the AP can turn around and sell those new ETF shares for $30/share and pocket the gain. If you switch the prices around, the AP would then take the ETF shares and exchange them for the underlying securities in the same way and make a profit on the difference. SEC also notes this same process.
great example of levered tracking error is any 2x/3x VIX etf. during periods of high volatility (like last week) you will be able to realize much higher returns on the underlying index as the levered and inverse ETFs are unable to replicate their intended performance using market securities.  it is not uncommon to see the VIX up ~30% with levered ETFs only netting ~10-12% as opposed to the intended 60 or 90%, for example In your other question about these funds you quoted two very different yields for them. That pretty clearly says they are NOT tracking the same index. The way it is handled with ETF's is that someone has to gather a block of units and redeem them with the fund. So, with the mutual fund you redeem your unit directly with the fund, always, you never sell to another player. With the ETF - its the opposite, you sell to another player. Once a player has a large chunk of units - he can go to the fund and redeem them. These are very specific players (investment banks), not individual investors. "In theory, the idea is that diversified assets will perform differently in different circumstances, spreading your risk around. Whether that still functions in practice is a decent question, as the ""truth"" of most probability based arguments for diversification rely on the different assets being at least somewhat uncorrelated. This article suggests that might not be true. Specifically: The correlations we note among industry sectors are profoundly and dysfunctionally high. and  Gold and silver traders have gotten too used to the negative correlation trade with stocks. This is, in fact, an unusual relationship for precious metals tostocks. The correlation should actually be zero." The key two things to consider when looking at similar/identical ETFs is the typical (or 'indicative') spread, and the trading volume and size of the ETF. Just like regular stocks, thinly traded ETF's often have quite large spreads between buy and sell: in the 1.5-2%+ range in some cases. This is a huge drain if you make a lot of transactions and can easily be a much larger concern than a relatively trivial difference in ongoing charges depending on your exact expected trading frequency. Poor spreads are also generally related to a lack of liquidity, and illiquid assets are usually the first to become heavily disconnected from the underlying in cases where the authorized participants (APs) face issues. In general with stock ETFs that trade very liquid markets this has historically not been much of an issue, as the creation/redemption mechanism on these types of assets is pretty robust: it's consequences on typical spread is much more important for the average retail investor. On point #3, no, this would create an arbitrage which an authorized participant would quickly take advantage of. Worth reading up about the creation and redemption mechanism (here is a good place to start) to understand the exact way this happens in ETFs as it's very key to how they work. In my experiences most hedge funds won't have a benchmark in their mandate and are evaluated based upon absolute returns.  Their benchmarks are generally cash + x basis points.  So, no attribution and no IR.  No experience at all with CTA's though, so not sure how things are there. "In an attempt to express this complicated fact in lay terms I shall focus exclusively on the most influential factor effecting the seemingly bizarre outcome you have noted, where the price chart of VIX ETFs indicates upwards of a 99% decrease since inception. Other factors include transaction costs and management fees.  Some VIX ETFs also provide leveraged returns, describing themselves as ""two times VIX"" or ""three times VIX"", etc. Regarding the claim that volatility averages out over time, this is supported by your own chart of the spot VIX index. EDIT It should be noted that (almost) nobody holds VIX ETFs for anything more than a day or two.  This will miminise the effects described above.  Typical daily volumes of VIX ETFs are in excess of 100% of shares outstanding.  In very volatile markets, daily volumes will often exceed 400% of shares outstanding indicating an overwhelming amount of day trading." "I wonder if ETF's are further removed from the actual underlying holdings or assets giving value to the fund, as compared to regular mutual funds. Not exactly removed. But slightly different. Whenever a Fund want to launch an ETF, it would buy the underlying shares; create units. Lets say it purchased 10 of A, 20 of B and 25 of C. And created 100 units for price x. As part of listing, the ETF company will keep the purchased shares of A,B,C with a custodian. Only then it is allowed to sell the 100 units into the market. Once created, units are bought or sold like regular stock. In case the demand is huge, more units are created and the underlying shares kept with custodian.  So, for instance, would VTI and Total Stock Market Index Admiral Shares be equally anchored to the underlying shares of the companies within the index? Yes they are. Are they both connected? Yes to an extent. The way Vanguard is managing this is given a Index [Investment Objective]; it is further splitting the common set of assets into different class. Read more at Share Class. The Portfolio & Management gives out the assets per share class. So Vanguard Total Stock Market Index is a common pool that has VTI ETF, Admiral and Investor Share and possibly Institutional share. Is VTI more of a ""derivative""? No it is not a derivative. It is a Mutual Fund." "They don't, actually. Though in some time frames S&P 500 growth out performs S&P 500, it often lags. This is because ""growth"" doesn't refer to what happens to your account, but rather the type of stock in the index -- roughly speaking, it's the half of the S&P with the best earnings growth.  That would be great, except it's not looking for is to see if that growth is worth buying. A stock with a 20% growth rate is a great buy at a P/E of 15, but a terrible buy at P/E/ 50.  That leads to what JB King was talking about -- there's also the S&P 500 Value, which is roughly the cheapest stocks relative to earnings. Value does tend to beat the broad index over the long haul, because there's nothing like getting a good deal (note a stock can be in both the growth and value categories). This holds true with other indexes as well like the Russel 2000. All that said, you're not going to see a huge difference between S&P 500 and S&P 500 Growth. I believe this is because the S&P 500 itself leans a bit to the growthy side.   PS: With VOOG Vanguard is tracking the S&P 500 Growth Index, which is actually a thing and not Vanguard itself filtering stocks." "The most fundamental answer is that when you short a stock (or an ETF), you short a specific number of shares on a specific day, and you probably don't adjust this much as the price wobbles goes up and down. But an inverse fund is not tied to a specific start date, like your own transaction is.  It adjusts on an ongoing basis to maintain its full specified leverage at all times.  If the underlying index goes up, it has to effectively ""buy in"" because its collateral is no longer sufficient to support its open position.  On the other hand, if the underlying index goes down, that frees up collateral which is used to effectively short-sell more of the underlying.  So by design it will buy high and sell low, and so any volatility will pump money out of the fund. I say ""effectively"" because inverse funds use derivatives and contracts, rather than actually shorting the underlying security.   Which brings up the less fundamental issue.  These derivatives and contracts are relatively opaque; the counter-parties are in it for their own benefit, not yours; and the people who run the fund get their expenses regardless of how you do, and they are hard for you to monitor.  This is a hazardous combination." UNG    United States Natural Gas Fund  Natural Gas USO    United States Oil Fund  West Texas Intermediate Crude Oil UGA    United States Gasoline Fund     Gasoline DBO    PowerShares DB Oil Fund     West Texas Intermediate Crude Oil UHN    United States Heating Oil Fund  Heating Oil I believe these are as close as you'd get. I'd avoid the double return flavors as they do not track well at all.  Update - I understand James' issue. An unmanaged single commodity ETF (for which it's impractical to take delivery and store) is always going to lag the spot price rise over time.   And therefore, the claims of the ETF issuer aside, these products will almost certain fail over time. As shown above, When my underlying asset rises 50%, and I see 24% return, I'm not happy. Gold doesn't have this effect as the ETF GLD just buys gold, you can't really do that with oil. You cannot do a 1031 exchange with stocks, bonds, mutual funds, or ETFs.  There really isn't much difference between an ETF and its equivalent index mutual fund. Both will have minimal capital gains distributions. I would not recommend selling an index mutual fund and taking a short-term capital gain just to buy the equivalent ETF. Interesting, but I don't think we are talking the same thing. This seems to say that that the fund itself doesn't have the rule applied: I.E. the MF can't get hit with the 5% commission when you buy it.  That makes sense.  What I'm asking though is that when my (say) American Fund that I own already does a rebalance, the constituent holdings change. Those securities are not exempt from the rule and thus when they are transacted can have commissions applied.  As a matter of fact the broker for those securities has no idea if the fund is eligible or not.   Where did you get this from? As I'm. It studying for a series 7 I'm probably missing some foundational sources. "I'm assuming the question is about how to compare two ETFs that track the same index. I'd look at (for ETFs -- ignoring index funds): So, for example you might compare SPY vs IVV: SPY has about 100x the volume. Sure, IVV has 2M shares trading, so it is liquid ""enough"". But the bigger volume on SPY might matter to you if you use options: open interest is as much as 1000x more on SPY. Even if you have no interest in options, the spreads on SPY are probably going to be slightly smaller. They both have 0.09% expense ratios. When I looked on 2010-9-6, SPY was trading at a slight discount, IVV was at a slight premium. Looking for any sort of trend is left as an exercise to the reader... Grab the prospectus for each to examine the rules they set for fund makeup. Both come from well-known issuers and have a decent history. (Rather than crazy Uncle Ed's pawn shop, or the Central Bank of Stilumunistan.) So unless you find something in the SPY prospectus that makes you queasy, the higher volume and equal expense ratios would seem to suggest it over IVV. The fact that it is at a (tiny) discount right now is a (tiny) bonus." As Sean pointed out they usually mean LIBOR or the FFR (or for other countries the equivalent risk free rate of interest). I will just like to add on to what everyone has said here and will like to explain how various interest rates you mentioned work out when the risk free rate moves: For brevity, let's denote the risk free rate by Rf, the savings account interest rate as Rs, a mortgage interest rate as Rmort, and a term deposit rate with the bank as Rterm. Savings account interest rate: When a central bank revises the overnight lending rate (or the prime rate, repo rate etc.), in some countries banks are not obliged to increase the savings account interest rate. Usually a downward revision will force them to lower it (because they net they will be paying out = Rf - Rs). On the other hand, if Rf goes up and if one of the banks increases the Rs then other banks may be forced to do so too under competitive pressure. In some countries the central bank has the authority to revise Rs without revising the overnight lending rate. Term deposits with the bank (or certificates of deposit): Usually movements in these rates are more in sync with Rf than Rs is. The chief difference is that savings account offer more liquidity than term deposits and hence banks can offer lower rates and still get deposits under them --consider the higher interest rate offered by the term deposit as a liquidity risk premium. Generally, interest rates paid by instruments of similar risk profile that offer similar liquidity will move in parallel (otherwise there can be arbitrage). Sometimes these rates can move to anticipate a future change in Rf. Mortgage loan rates or other interests that you pay to the bank: If the risk free rate goes up, banks will increase these rates to keep the net interest they earn over risk free (= Δr = Rmort - Rf) the same. If Rf drops and if banks are not obliged to decrease loan rates then they will only do so if one of the banks does it first. P.S:- Wherever I have said they will do so when one of the banks does it first, I am not referring to a recursion but merely to the competitive market theory. Under such a theory, the first one to cut down the profit margin usually has a strong business incentive to do so (e.g., gain market share, or eliminate competition by lowering profit margins etc.). Others are forced to follow the trend.