What is tracking error of a portfolio?
Isabella Ramos
Updated on February 26, 2026
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 causes tracking error in ETFS?
key takeaways. The difference between the returns of the index fund and its benchmark index is known as a fund’s tracking error. SEC diversification rules, fund fees, and securities lending can all cause tracking errors. Tracking errors tend to be small, but they can still adversely affect your returns.
How important is tracking error?
Tracking error is one of the most important measures used to assess the performance of a portfolio, as well as the ability of a portfolio manager to generate excessive returns and beat the market or the benchmark. Due to the abovementioned reasons, it is used as an input to calculate the information ratio.
Can you have a negative tracking error?
It’s important to remember that tracking error describes the size of the difference in relative return, not whether it was positive or negative. But the greater the tracking error, the greater the possibility for very negative or very positive excess returns.
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 ex post tracking error?
A realized (also known as “ex post”) tracking error is calculated using historical returns. A tracking error whose calculations are based on some forecasting model is called an “ex ante” tracking error. Low errors indicate that the performance of the portfolio is close to the performance of the benchmark.
What is a tracking portfolio?
Definition: A tracking portfolio is a portfolio of financial securities whose return minimizes the variance of the difference between the tracking portfolio and the portfolio that is being tracked. Consider the market for Treasuries since that is as close as we can get to a “riskless security.
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.
How do you track portfolio performance?
Top Methods to Track Your Stocks
- Use Online Tracking Services: Robo Advisors and Brokerages.
- Track Your Investment with Personal Finance Apps.
- DIY With Spreadsheets.
- Use Desktop Apps for Investment Tracking.
- Start Using a Trading Journal.
What is the ex-post tracking error formula?
The ex-post tracking error formula is the standard deviation of the active returns, given by: where r p − r b {displaystyle r_{p}-r_{b}} is the active return, i.e., the difference between the portfolio return and the benchmark return.
How do you calculate the tracking error for a portfolio?
There are two formulas to calculate the tracking error for a portfolio. The first method is to simply take the difference between the portfolio return and the return from the index it is trying to replicate. Tracking Error Formula = Rp-Ri. Rp= Return from the portfolio. Ri= Return from the index.
Do fund managers have a higher ex-post tracking error than planned?
Our results imply that fund managers always have a higher ex-post tracking error than their planned tracking error, and thus unless our results are considered, any performance fee based on ex-post tracking error is unfavourable to fund managers. Content may be subject to copyright. Stephen E. Satchell!
What is tracking error in index funds?
Tracking Error. Tracking error refers to the difference in returns between a portfolio (index fund) and a benchmark (target index) against which its performance is evaluated. In other words, it is the difference between the returns on an index fund and the returns on a target index.
