A portfolio manager is considering investing a significant portion of a client's growth-oriented portfolio into an ETF designed to track the S&P/TSX Composite Index. The manager is particularly concerned about the precise replication of the index's performance over various market conditions. Which of the following factors is most likely to contribute to 'tracking error' for this type of ETF? A. The ETF's management expense ratio (MER). B. The frequency of the index rebalance by the index provider. C. The inclusion of derivatives for synthetic replication. D. The bid-ask spread of the underlying securities.

Question: A portfolio manager is considering investing a significant portion of a client's growth-oriented portfolio into an ETF designed to track the S&P/TSX Composite Index. The manager is particularly concerned about the precise replication of the index's performance over various market conditions. Which of the following factors is most likely to contribute to 'tracking error' for this type of ETF?

A. The ETF's management expense ratio (MER). B. The frequency of the index rebalance by the index provider. C. The inclusion of derivatives for synthetic replication. D. The bid-ask spread of the underlying securities.

Answer options: ✅ A. The ETF's management expense ratio (MER).

• B. The frequency of the index rebalance by the index provider.
• C. The inclusion of derivatives for synthetic replication.
• D. The bid-ask spread of the underlying securities.

Correct answer: A. The ETF's management expense ratio (MER).

Explanation: The management expense ratio (MER) is a direct cost to the ETF and, therefore, to the unitholders, which reduces the ETF's return relative to the gross return of the underlying index. This consistent drag directly contributes to tracking error. While other factors listed can influence tracking error, MER is a guaranteed and significant contributor for passively managed index-tracking ETFs.