Fees come first

The expense ratio is deducted from net assets a little each day. At 0.5% a year, expect to trail the index by roughly that after twelve months.

Less an error than a scheduled subtraction — and the most predictable reason two funds on one index diverge.

Rebalancing leaks

When the index changes, the fund has to trade. Commissions and spreads are costs the index never pays: it is calculated on paper, the fund has to place orders.

The more a index turns over, the larger this is — which is why thematic and strategy funds track less tightly than broad ones.

Large funds can also move prices against themselves when they trade in size.

How dividends are handled

Many indices assume dividends are reinvested the moment they go ex. Real funds receive cash later, and often after withholding tax.

A distributing fund's net assets drop by whatever it pays out, so return comparisons shift depending on whether distributions are counted.

Withholding differs by country, which widens the effect for international holdings.

When the fund does not hold everything

Owning every name in a several-thousand-stock index is inefficient, so funds sample: hold a subset chosen to behave like the whole.

It works most of the time, and drifts when something left out moves sharply.

So compare realised tracking difference, not just the headline fee. A cheap fund that follows its index poorly has saved you nothing.

Difference and error are not the same

The terms get mixed but measure different things. Tracking difference is the gap in period return — how far behind. Tracking error is how much that gap wobbles day to day.

Long-term holders should care about difference. Trailing the index by 0.6 points a year compounds. Error is daily dispersion and can wash out over time.

Read together they point at the cause. Large difference with small error means something leaks steadily, like cost. Large error means irregular factors — rebalancing, liquidity — are involved.

Separating the leaks

The fee is the certain one. Deducted daily, it is a scheduled difference: a 0.3% fund should trail by 0.3 points a year, all else equal.

Trading costs come next. Index changes force real orders, and orders pay commission and spread. The index itself is computed on paper and pays neither.

Dividend handling matters too. Indices often assume instant reinvestment while a real fund waits for settlement and may have tax withheld — plus foreign withholding on overseas assets.

How to check it

Line up same-index candidates in the compare screen and read fee next to recent return. A lower fee with a lower return means something is leaking beyond the fee.

Do not judge on one period. A single quarter can flip on rebalance timing. Consistent lag across several periods is what indicates a structural problem.