Disadvantages

♤ Tracking error- Though no ETF can completely replicate its underlying index, a noticeable tracking error can be witnessed in strategies which may not allow complete replication of the index due to liquidity issues, like leverage strategies or ETFs investing in commodities.

♤ Illiquid due to small size- For relatively small funds, it may be difficult to completely replicate an index, which may not only increase its tracking error but also make it illiquid, especially in times of distress.

♤ Tax implications- For ETFs which invest beyond the traditionally popular asset classes of equities and fixed income, investors need to exercise caution as apart from an increased tracking error, tax implications may be high at best or unclear at worst, which may have a sizable impact on returns.