How does the ETF track the performance of the underlying index

Most ETFs track the underlying indexes through the following three strategies:

1. Fully Replicate The Strategy

Such as the Tracker Fund (02800). The fund manager will invest in these index stocks according to the proportion of the benchmark index components. Fund managers can closely replicate the performance of benchmark indexes. The advantage of this replication strategy is that it enables the ETF to achieve the most accurate tracking, while the disadvantage is that the cost and transaction fees are higher, especially when the index constituents are numerous or less circulated.


2. Representative Sampling Replication Strategy

Such as the S&W CSI Hong Kong 100 Index Fund (02825). The fund manager builds a portfolio that has similar returns, risk, market capitalization, and investment characteristics to the benchmark index. ETFs using this strategy is less expensive than the former because the portfolio holds fewer shares. However, it does not follow the index as closely as a full replication strategy, so there may be a degree of tracking error.


3. Synthetic Replication Strategies

Such as the Leading Global ETF (02812). ETFs using this strategy does not necessarily hold constituent stocks directly, but rather use derivatives such as equity-linked swaps to achieve a low-cost, performance-tracking effect. The fund manager is able to obtain an accurate performance of the benchmark index from the issuer of the equity-linked swap, thus ensuring near-full performance and low tracking error, but with higher counterparty risk, valuation risk, and liquidity risk.