What is tracking error investopedia?
Tracking error is the divergence between the price behavior of a position or a portfolio and the price behavior of a benchmark. This is often in the context of a hedge fund, mutual fund, or exchange-traded fund (ETF) that did not work as effectively as intended, creating an unexpected profit or loss.
What is an appropriate tracking error?
Theoretically, an index fund should have a tracking error of zero relative to its benchmark. Enhanced index funds typically have tracking errors in the 1%-2% range. Most traditional active managers have tracking errors around 4%-7%.
What causes tracking error?
Tracking error can be caused by two reasons. First, by the trading cost and second, by improperly replicating the index. For an ETF, tracking error is the deviation in performance of the fund and its index. It occurs primarily because of the ETF’s total expense ratio (a kind of trading cost).
What is tracking error volatility?
Tracking error, also known as active risk, measures, in standard deviation, the fluctuation of returns of a portfolio relative to the fluctuation of returns of a reference index. As such, it gives an indication of how closely a portfolio “tracks” or mimics its benchmark.
How important is tracking error?
Tracking error distills all the differences between a portfolio and its benchmark into a single number. It also plays an important client communication role in that it sets appropriate expectations for how large the difference between the benchmark and the portfolio return will likely be.
Can you have a negative tracking error?
Tracking difference, which can be positive or negative, tells you the extent to which a fund has out- or underperformed its benchmark index. Because a fund’s NAV total return includes fund expenses, tracking difference typically is negative for index funds.
What does a tracking error of 1 mean?
So, for example, we could say a portfolio has a tracking error relative to its benchmark of 1% per year. For a portfolio with a normal distribution of excess returns and an annualized tracking error of 1%, we would expect its return to be within 1% of its benchmark return approximately two out of every three years.
What is high tracking error?
Low tracking error means a portfolio is closely following its benchmark. High tracking errors indicates the opposite. Thus, tracking error gives investors a sense of how “tight” the portfolio in question is around its benchmark or how volatile the portfolio is relative to its benchmark.
Should tracking error be Annualized?
Tracking error is the annualized standard deviation of daily return differences between the total return performance of the fund and the total return performance of its underlying index. In laymen’s terms, tracking error basically looks at the volatility in the difference of performance between the fund and its index.
What’s considered a low tracking error?
What does a low tracking error mean?
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