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why do PowerShares RAFI ETFs underperform their underlying indices?
The RAFI indices look to be an appealing alternative to market weighted indices. PowerShares has ETFs that follow the RAFI indices, but many seem to underperform their underlying index, PFX and PDN by about 1.2%. The expense ratios on those two is .75% leaving nearly half a percent unaccounted for which seems rather high for tracking error. Does anyone have an idea about what might account for the difference?
Possibly trading costs (from bid-ask spreads) which are the costs you do not see in expense ratio. Since these indices are not cap weighted they trade more often than conventional cap weighted index funds and since they tend to be more small cap weighted their bid-ask spreads will be higher.
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