WHY PASSIVE FUNDS CAN UNDERPERFORM A BENCHMARK
They experience tracking error as they cannot perfectly match the performance of the benchmark. This tracking error is greatest in periods where constituents are added and/or removed from a benchmark. 2
Passive funds charge fees to cover the administration of the fund’s assets, transactional costs and management fees. As a result, in a perfect world, where there is no tracking error, passive funds will always underperform their benchmark due to these costs.