Tracking difference

The TER — total expense ratio — is the cost a fund promises to charge. Tracking difference is the cost it actually charged, measured the only way that matters: index return minus fund return, over a real period.

The two diverge because the TER is only one line in the fund’s economics. On top of it sit costs the TER does not capture — the internal cost of trading when the index rebalances, taxes on dividends along the way. Below it sits revenue the TER does not show — most notably securities lending, where the fund lends its holdings to short sellers for a fee and passes some of that income back. Net all of it and you get the tracking difference. Two funds with an identical TER can deliver materially different results over a decade, and the fund with the higher headline fee is sometimes the cheaper one in practice.

Tracking difference should not be confused with tracking error, which measures how volatile the gap is day to day rather than how large it ends up. For a long-term holder, the difference is what compounds; the error is mostly noise.

Where to find it: fund providers publish the numbers, and independent comparison sites tabulate several years of tracking difference per fund. How to use it — alongside fund size, replication method and domicile — is check number one in the article below.