ETF tracking error and liquidity: why two ETFs on the same index can cost you very different amounts

1. Index to NAV. The fund's portfolio, after its expenses, cash and dividend timing, does not match the index exactly. This is what tracking error and tracking difference measure.
2. NAV to market price. Units trade on the exchange at whatever buyers and sellers agree. The price can sit above the NAV (a premium) or below it (a discount).
3. Market price to you. The spread between the best buy and sell quotes, and the impact of your own order on a thin book.

SEBI's rules address the first gap directly and the second through market makers and disclosure. The third is yours to manage. The module on how ETFs work covers the mechanics of creation and redemption that tie the gaps together.

• Tracking error is defined as "the annualized standard deviation of the difference in daily returns" between the index and the NAV, over the past year. For ETFs and index funds other than debt it shall not exceed 2%, except in force majeure, and it is disclosed every day on the AMC and AMFI websites.
• Tracking difference, the annualised return gap, is disclosed monthly for 1, 3, 5 and 10 years and since allotment.
• iNAV, the live value of the portfolio per unit, is shown on the exchange through the day: within 15 seconds for equity ETFs; for gold and international ETFs it may be static when the underlying market is shut.
• Market makers: each AMC appoints at least two exchange members to provide continuous quotes.
• Direct dealing with the AMC is for orders above ₹25 crore (from 1 May 2023); everyone else buys and sells on the exchange.

Part of that is dividends: the price index drops when a constituent goes ex dividend, while the fund keeps the cash.

Over the full year, the NAV of Nifty BeES fell 10.41% while the Nifty 50 price index fell 11.35%. The fund's NAV beat the price index because it kept the dividends; against the Nifty 50 total return index, which counts dividends, it would trail by about its expenses. That return gap is the tracking difference, and for a plain Nifty 50 ETF it is mostly the expense ratio. The note TRI vs price index explains which Nifty a fund should be measured against, and the tracking error calculator computes both figures from your own return series.

The busy funds closed within about 0.1% of NAV on a typical day and rarely more than 0.5% away. The thin ones were usually close too, which is the trap: a typical day says little about the day you need to trade. On 11 to 16 Dec 2025, Bandhan's Nifty 50 ETF closed 13% to 19% above its NAV, with as little as ₹19 lakh changing hands; anyone who bought then paid for a basket of Nifty 50 shares at nearly a fifth more than it was worth.

International ETFs can drift much further. When new units cannot be created freely, for example when a fund house pauses fresh subscriptions, buyers bid the price above the value of the holdings and nothing pulls it back.

On 12 Oct 2026 MON100 closed at ₹324.21 against a NAV of ₹287.02: a buyer paid 12.96% more than the shares underneath were worth. If that premium shrinks to zero, the investor loses it even if the Nasdaq 100 does not move.

• Pick the busy fund on the index you want. Trading volume, not the expense ratio alone, decides what you pay on the way in and out. A fund that trades crores a day usually trades close to NAV.
• Compare the price with the iNAV shown on the exchange or the AMC's site before you place the order. More than a few tenths of a percent apart on an equity ETF is a warning.
• Use a limit order near the iNAV rather than a market order, especially in a thin fund.
• Be careful at odd hours. At the open, close, special sessions, and when the underlying market is shut (gold on a weekend session, US shares during Indian hours), the iNAV may be stale and gaps widen.
• For international ETFs, check the premium first. When it is large, a fund of funds on the same index, which deals at NAV, avoids it.

The direct indexing guide covers the other way to hold an index: owning the shares yourself, with no NAV and no premium, but with every rebalance taxed in your hands. The note ETF vs index fund compares the two fund routes.

A RupeeCase rule holds the shares themselves in your own demat, so there is no NAV, premium or discount between you and the holdings; your costs are the spread and impact on each stock at each rebalance, plus the fee. Nifty 50 Equal Weight holds 50 stocks in equal amounts, rebalanced every 4 weeks: model CAGR 16.35%, deepest fall −15.71%, as of 27 Apr 2026.