Is ETF Backtested Data a Reliable Indicator?

ETF Trends

Exchange traded fund sponsors are now able to provide backtested data on new products to generate interest among institutional investors, but historical data is not a perfect indicator for future performance.

In a white paper published last July, Vanguard senior investment strategist Joel Dickson tracked 370 indices with a backtested annualized excess return of 10% over the past five years and found that the average index underperformed the benchmark by 1% after the the indices went live, reports Jackie Noblett for Ignites.

“It appears that index creation activity has been transformed from an exercise of providing investable benchmarks for different asset class segments to one of providing ETFs a way to market and promote new products with ready-made indexes that might jump-start the acceptance and viability of new offerings,” Dickson said in the white paper.

The ETF industry is adopting more strategy-based indexing methodologies as it relies on newer or custom-built indices. According to Vanguard research, about 60% of the indices that serve as benchmarks for ETFs launched between 2000 and 2011 were less than a year old when the ETFs went live.

Last week, the Financial Industry Regulatory Authority issued a new guidance that allowed providers to send “pre-inception index performance,” or historical market data that showed theoretical performance, to institutional investors. ETF sponsors are still not allowed to provide the data directly to retail investors. [ETF Sponsors Can Provide Backtested Data to Institutional Investors]

Some market observers have argued that sophisticated investors, such as institutions, will be able to make an informed decision through backtested data.

“The more history you can provide, the better equipped an investor is to understand an index and make a decision,” Bill Belden, head of product development at Guggenheim Investments, said in the article.

Nevertheless, Belden notes that the FINRA ruling will not be a “game-changer” as institutional investors know the difference between backtested data and live performance expectations.

For more information on ETFs, visit our ETF 101 category.

Max Chen contributed to this article.

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