XEQT Tracking Error Explained: Is Your ETF Actually Doing Its Job?

I remember the first time I compared my XEQT returns to “the market.” It was the end of 2023, and every financial headline was shouting about how global equities had delivered strong double-digit gains. I opened my Wealthsimple account, looked at my XEQT position, and the number was… a little lower than what the headlines said. Not dramatically lower. Not panic-inducing. But noticeably off by what looked like a fraction of a percent.

My first thought was that something was wrong. Had I bought at a bad time? Was the ETF broken? Was BlackRock skimming extra fees off the top?

Turns out, nothing was wrong. What I was seeing was completely normal, and it has a name: tracking error. Once I understood what it was and why it happens, I stopped worrying about it entirely. If you have ever had that same moment of doubt looking at your XEQT returns, this post is for you.

1. What Tracking Error and Tracking Difference Actually Mean

Before we dig into the specifics of XEQT, let’s get two terms straight. They sound similar but mean different things, and most people (including some financial writers) mix them up.

Tracking difference is the total gap between your ETF’s return and its benchmark’s return over a specific period. Think of it like this: if the benchmark returned 10.00% in a year and your ETF returned 9.82%, the tracking difference is -0.18%. It is a single number that tells you how much your fund lagged (or, rarely, beat) the index over that time frame.

Tracking error is the volatility or inconsistency of that gap over time. It measures how much the daily or monthly differences between the ETF and its benchmark bounce around. A fund could have a small tracking difference for the year but a high tracking error if the daily deviations were all over the place.

Here is a simple analogy. Imagine you are following a friend who is driving to a cottage. Tracking difference is how many minutes behind them you arrive at the end of the trip. Tracking error is how much the distance between your two cars varied throughout the drive. Maybe you fell behind at a traffic light, caught up on the highway, and fell behind again in a construction zone. The bumpier the gap, the higher the tracking error.

For most buy-and-hold XEQT investors, tracking difference matters more than tracking error. You care about where you end up at the destination, not how bumpy the ride was in between.

2. Why an ETF Can Never Perfectly Track Its Benchmark

Here is something that surprises new investors: no ETF on the planet tracks its benchmark perfectly. It is literally impossible. The benchmark index is a mathematical concept – it has no trading costs, no taxes, and no real-world frictions. Your ETF lives in the real world. That gap is unavoidable.

Here are the main reasons XEQT (or any ETF) will always lag its benchmark slightly:

Management Expense Ratio (MER) Drag

This is the biggest and most predictable drag. XEQT has an MER of 0.20%, which means BlackRock deducts roughly 0.20% per year from the fund’s assets to cover management, administration, and operating costs. If the benchmark returns exactly 10.00%, the best you can reasonably hope for from XEQT is around 9.80%, all else being equal.

The MER is baked into the fund’s daily net asset value (NAV), so you never see a line item on your statement saying “fee deducted.” It just silently reduces your returns by a tiny fraction each day.

Cash Drag

An ETF needs to hold a small amount of cash at all times to handle daily redemptions and creations. The benchmark index assumes 100% of assets are invested at all times. That small cash balance earns close to nothing compared to the equity market, so it creates a slight drag.

Sampling vs. Full Replication

Some ETFs do not hold every single stock in their benchmark index. Instead, they hold a representative sample. This is called sampling or optimization. The idea is to closely match the index’s characteristics (sector weights, market cap distribution, etc.) without buying every tiny stock. This introduces small deviations.

XEQT’s underlying funds use a mix of approaches. ITOT (the U.S. component) holds thousands of stocks and essentially fully replicates its index. The international and emerging markets components may use some degree of optimization because those markets have thousands of smaller, harder-to-trade stocks.

Trading Costs

Every time the ETF needs to buy or sell securities – to handle inflows, outflows, or rebalancing – it incurs real trading costs: bid-ask spreads, commissions, and market impact. The benchmark index “rebalances” for free because it is just math on paper.

Foreign Withholding Taxes

This is a big one for a globally diversified fund like XEQT. When a U.S. company pays a dividend, the IRS withholds 15% of that dividend before it reaches the Canadian ETF. When a European company pays a dividend, their government takes a cut too. These foreign withholding taxes reduce the fund’s actual return, but the benchmark index typically assumes dividends are received in full (gross of withholding taxes) or uses a net-of-tax version.

For XEQT, this is especially relevant because roughly 75% of the portfolio is invested outside of Canada. The withholding tax drag on international dividends can add up to 0.20-0.40% per year depending on the account type (TFSA, RRSP, or taxable) and the specific benchmark being compared against.

Rebalancing Costs

XEQT rebalances its underlying holdings to maintain its target geographic allocation. This means periodically selling what has gone up and buying what has gone down. The benchmark allocation shifts naturally with market cap changes, but XEQT’s fixed-weight mandate means it needs to actively trade to get back to target. Those trades cost money.

3. XEQT’s Unique Tracking Situation: A Fund of Funds

Here is where XEQT gets a little more interesting than a typical index ETF. XEQT is not a fund that directly holds thousands of individual stocks. Instead, it is a fund of funds – it holds other iShares ETFs, which in turn hold the actual stocks.

As of its most recent holdings, XEQT holds:

• ITOT – iShares Core S&P Total U.S. Stock Market ETF (~45% of the portfolio)
• XEF – iShares Core MSCI EAFE IMI Index ETF (~25%)
• XIC – iShares Core S&P/TSX Capped Composite Index ETF (~25%)
• XEC/IEMG – iShares Core MSCI Emerging Markets ETF (~5%)

This means there are two levels of tracking happening:

1. Level 1: Each underlying ETF (ITOT, XEF, XIC, XEC) tracks its own benchmark index. Each one has its own MER, its own cash drag, and its own tracking error.
2. Level 2: XEQT itself tracks its blended benchmark by holding these underlying ETFs in the right proportions. XEQT has its own additional MER layer (though BlackRock is careful not to double-charge – XEQT’s stated MER of 0.20% includes the fees of the underlying funds).

The good news is that BlackRock has structured this efficiently. You are not paying two layers of fees. The 0.20% MER you see for XEQT is the all-in cost, inclusive of the underlying fund fees. But the tracking imperfections at each level can compound slightly.

Think of it like a relay race. Each underlying ETF is a runner, and each runner’s slight imperfections in speed get passed along. XEQT, as the team, inherits the cumulative imperfections of all its runners, plus whatever friction it adds in the handoff (rebalancing between the underlying funds).

In practice, this double layer has not been a significant problem. The underlying iShares ETFs are massive, liquid, and well-managed. ITOT alone has hundreds of billions in assets.

4. What “Good” Tracking Looks Like

So what numbers should you actually expect? How do you know if XEQT is doing a good job?

For a simple single-index ETF (like one that just tracks the S&P 500), a tracking difference of less than 0.10% beyond the MER would be considered excellent. For an all-in-one fund of funds like XEQT, which has to manage four underlying ETFs across multiple countries, currencies, and tax jurisdictions, the bar is a bit more forgiving.

Here is a rough guide:

For XEQT specifically, anything under 0.30% annually beyond the MER is excellent tracking for an all-in-one global equity ETF. When you see XEQT lag its benchmark by, say, 0.25-0.40% in a given year, remember that roughly 0.20% of that is the MER you already knew about. The remaining 0.05-0.20% is the real-world friction we discussed above.

Over XEQT’s history since its 2019 launch, its tracking has generally been in the “very good” range. There have been individual quarters where it slightly outperformed or underperformed the benchmark by more than usual, but over rolling one-year periods, the tracking difference has been remarkably consistent and close to what you would expect given the MER and foreign withholding taxes.

Some things that can make tracking look worse than it actually is:

• Comparing against the wrong benchmark. If you compare XEQT’s return to the S&P 500 or the TSX alone, you will get a misleading picture. XEQT tracks a blended global benchmark, not any single-country index.
• Not accounting for currency effects. XEQT holds foreign assets in foreign currencies. If the Canadian dollar strengthened during a period, your CAD-denominated returns will look lower than the foreign-currency benchmark returns.
• Looking at price return instead of total return. XEQT pays dividends. If you compare XEQT’s price change (without dividends) to a total return benchmark (with dividends), you will think the tracking is terrible.

5. Premium and Discount to NAV

There is another source of “tracking” confusion that has nothing to do with the fund’s actual performance: the premium or discount to net asset value (NAV).

Every ETF has a NAV, which is the per-share value of all the holdings inside the fund. This is calculated at the end of each trading day. But the ETF also has a market price, which is whatever buyers and sellers on the stock exchange agree to trade it for throughout the day.

When the market price is higher than the NAV, the ETF trades at a premium. When it is lower, it trades at a discount. For large, liquid ETFs like XEQT, this gap is usually tiny – often less than 0.05%. But it can widen during periods of market stress or heavy trading.

Here is why it matters for your perceived returns:

• If you bought XEQT at a 0.10% premium and later it trades at a 0.10% discount, you have “lost” 0.20% that has nothing to do with the fund’s actual investment performance.
• Conversely, if you bought at a discount and it moves to a premium, you got a small bonus return.

For most long-term XEQT investors, premium/discount fluctuations are noise. They wash out over time. But if you are calculating XEQT’s tracking difference over a specific period, be aware that using market prices (what your brokerage shows you) instead of NAV can make the tracking look slightly better or worse than it actually was.

How to check XEQT’s premium/discount: The iShares Canada website publishes daily NAV data alongside market price data. You can compare the two to see whether XEQT is currently trading at a premium or discount.

6. How XEQT’s Tracking Compares to Competitors

XEQT is not the only all-in-one equity ETF in Canada. Let’s see how its tracking stacks up against the main competitors.

XEQT vs. VEQT (Vanguard)

VEQT (Vanguard All-Equity ETF Portfolio) is XEQT’s closest competitor. Both are 100% equity, both are fund-of-funds structures, and both have very similar geographic allocations.

Because VEQT has a slightly higher MER (0.24% vs. 0.20%), you would expect its tracking difference to be slightly larger, all else being equal. In practice, this has generally been the case, though the difference is small enough that it rarely matters in any single year. Both funds track well.

XEQT vs. ZEQT (BMO)

ZEQT (BMO All-Equity ETF) is the newer entrant, launched in 2021. It also has an MER of 0.20%, matching XEQT.

ZEQT has a shorter track record, which makes it harder to draw definitive conclusions about tracking quality. From the data available so far, ZEQT’s tracking has been comparable to XEQT’s. There is no clear winner on tracking quality alone.

The Bottom Line on Competitors

All three of these all-in-one equity ETFs track their benchmarks well. The differences between them are measured in hundredths of a percent. You should choose between them based on other factors – MER, provider preference, account platform, geographic allocation preferences – not tracking error. If tracking error is the tiebreaker in your decision, you are overthinking it.

7. Why Tracking Error Should Not Change Your Investment Strategy

Let me put tracking error in perspective with some real numbers.

Let’s say XEQT returns 8.5% in a year while its benchmark returned 8.8%. That 0.30% tracking difference might feel annoying when you see it on paper. But consider the context:

• The difference between investing and not investing that year was 8.5%. Tracking error cost you 0.30%.
• The difference between XEQT and a typical Canadian mutual fund charging 2.0% MER would be roughly 1.80% per year. Tracking error is a fraction of the savings you already locked in by choosing a low-cost ETF.
• The difference between consistently investing and trying to time the market is often 2-4% per year according to most studies of investor behavior. Tracking error is a rounding error compared to the cost of bad timing decisions.

Here is a compounding example to drive the point home:

The gap between XEQT and the theoretical benchmark over 25 years is about $49,000. The gap between XEQT and a typical mutual fund is over $200,000. Tracking error is the cost of doing business in the real world – the toll you pay to drive on the highway. You would never skip the trip because of a $5 toll.

The most important thing you can do as an XEQT investor is not to minimize tracking error – it is to keep buying consistently, avoid panic selling, and let compounding do its work. The behavioral gap (the difference between what the fund returns and what the average investor earns because of poor timing) dwarfs tracking error by an order of magnitude.

8. Practical Tips: How to Check XEQT’s Tracking Yourself

If you want to keep an eye on XEQT’s tracking (and I think a periodic check is healthy, even if it should not drive your decisions), here is how to do it.

Step 1: Find XEQT’s Official Page

Go to the iShares Canada website and search for XEQT. The fund page will show you:

• NAV and market price (updated daily)
• Performance data (1-month, 3-month, YTD, 1-year, 3-year, 5-year, since inception)
• Benchmark performance alongside fund performance
• Premium/discount history

Step 2: Compare Fund Return to Benchmark Return

Look at the performance table on the iShares page. It will typically show XEQT’s return next to its benchmark return for various periods. The difference between these two numbers is the tracking difference.

Things to look for:

• Is the tracking difference roughly equal to the MER? If XEQT returned 9.78% and the benchmark returned 10.00%, the -0.22% gap is almost entirely explained by the 0.20% MER. That is excellent.
• Is the gap consistent across time periods? If the 1-year, 3-year, and 5-year tracking differences are all in a similar range, the fund is tracking reliably.
• Are there any sudden jumps? If one period shows a much larger gap than others, it might be due to a one-time event (like a large rebalancing trade or a change in foreign withholding tax rates).

Step 3: Check the Premium/Discount

On the same iShares page, look for the premium/discount to NAV data. This is usually shown as a chart or table. For XEQT, you should expect this to hover close to zero most of the time. Occasional blips of +/- 0.10% are normal.

Step 4: Compare Calendar-Year Returns

For a cleaner comparison, look at full calendar-year returns rather than trailing returns. Trailing returns (like “last 12 months”) shift every day, making it hard to compare consistently. Calendar-year returns (January 1 to December 31) give you a stable anchor.

Step 5: Do Not Obsess

Seriously. Check once or twice a year if you are curious. If the tracking difference is in the ballpark of 0.20-0.45%, close the tab and go enjoy your life. Your ETF is doing its job.

Here is a quick checklist for your annual tracking check:

• Visit the iShares Canada website for XEQT
• Compare the fund’s 1-year return to the benchmark’s 1-year return
• Confirm the gap is roughly in line with the MER (0.20%) plus a small amount for other frictions
• Check the premium/discount to NAV (should be close to zero)
• If everything looks normal, stop checking and go back to your regular contribution schedule

The Takeaway

XEQT’s tracking error is not a flaw – it is a feature of living in the real world. Every ETF has it. The question is not whether tracking error exists, but whether it is reasonable and predictable. For XEQT, the answer to both is yes.

The roughly 0.20-0.40% annual tracking difference you see with XEQT is almost entirely explained by its MER and foreign withholding taxes – costs that are either unavoidable or far lower than the alternatives (like mutual funds or building a DIY portfolio of individual ETFs). XEQT’s fund-of-funds structure adds minimal additional tracking friction, and its record since inception in 2019 has been solid and consistent.

If you are investing in XEQT through a TFSA, RRSP, or taxable account and contributing regularly, tracking error is the least of your concerns. The decisions that will actually determine your long-term wealth are how much you save, how consistently you invest, and whether you stay the course during market downturns. Those factors will dwarf any tracking difference by a factor of 10 or more.

So the next time you compare your XEQT returns to a headline number and notice a small gap, you can smile, nod, and say, “Yep, that is just tracking difference doing its thing.” Then go ahead and buy your next share.

Related Reading

• What is XEQT? A Comprehensive Guide
• XEQT MER: What You Need to Know
• VEQT vs XEQT: Which All-Equity ETF is Better?
• XEQT vs ZEQT: Which All-Equity ETF Wins?
• XEQT Automatic Rebalancing Explained
• Is XEQT a Good Investment?