Why Two S&P 500 ETFs Can Deliver Different Returns Over Time

Two exchange traded funds that track the same index can produce meaningfully different returns over time. The gap is not random. It comes from structural and operational choices that compound year after year.

One of the most misunderstood concepts is the difference between tracking error and tracking difference. Tracking error measures how consistently an ETF's returns follow the benchmark day-to-day. Tracking difference reflects the actual performance gap over time. An ETF can have low tracking error while consistently underperforming due to fees, taxes, and operational drag.

Fees are far from the only factor. A useful U.S.-based example is the long-term comparison between SPY and VOO. Both track the S&P 500. VOO has historically outperformed SPY. The reasons are structural.

SPY operates as a unit investment trust. That older structure cannot reinvest dividends before the quarterly distribution. Cash accumulates and sits idle, creating a cash drag. VOO uses the '40 Act structure, which allows immediate reinvestment of dividends. The immediate reinvestment reduces unproductive cash balances. The lower MER adds to the advantage, creating a small but consistent gap that compounds over time.

Canada provides another example. The BMO S&P 500 Index Series Units ETF directly holds the underlying S&P 500 stocks. BMO manages the portfolio as constituents change. The Vanguard S&P 500 Index ETF (VFV) takes a different approach. It gets exposure by holding the U.S.-listed VOO. That fund-of-funds model adds an operational layer. The Canadian investor relies on VOO to manage the S&P 500 portfolio correctly, while Vanguard Canada packages the result. Direct replication can be cleaner because the Canadian ETF owns the securities itself. Investors should evaluate actual tracking outcomes over time rather than making decisions based solely on structure, said Eli Yufest, executive director of the Canadian Exchange Traded Funds Association.

Currency management can also create meaningful tracking differences. The CAD-hedged version of the Vanguard S&P 500 ETF (VSP) tracks the same index as unhedged ETFs. Its returns diverge because of hedging costs and implementation challenges. Foreign withholding taxes and cash drag add further layers.

Securities lending is another important driver of returns. Many ETF providers lend portfolio securities to short sellers or institutional counterparties in exchange for a fee. That revenue can help offset fund expenses and improve performance. In some cases, securities lending revenue can partially or fully cover an ETF's MER. Programs differ across issuers in scale, collateral policies, revenue sharing, and risk controls. The benefit is not uniform.

Portfolio construction methodology also matters. Some ETFs fully replicate an index by holding every security in exact weighting. Others use sampling, holding a representative subset. Sampling can reduce transaction costs and improve operational efficiency, particularly in fixed income or international markets. It can also increase tracking differences if the sample fails to perfectly mirror benchmark performance.

Trading costs such as bid-ask spreads can affect investor outcomes, especially for less liquid ETFs, even when long-term tracking characteristics are similar.

Alpha Score data provides another lens. SPY carries a score of 38 out of 100, labeled Mixed. State Street Corp. (STT), the fund's sponsor, scores 73, a Moderate signal. That gap between the product and the issuer is worth noting for advisors selecting ETFs.

For advisors choosing between two ETFs with the same benchmark, implementation details determine the outcome. Fee differences, dividend policies, hedging methods, and lending programs all change the result. Yufest said the implementation of exposure matters as much as the exposure itself.