What is tracking error?

What is tracking error?

• A. The volatility of a stock’s price
• B. The correlation between two unrelated assets
• C. A measurable difference between the returns expected by the investor and the returns received
• D. The difference between gross and net returns after fees

Answer: (C)

Tracking error is the measure of how closely a portfolio's returns follow its benchmark. It captures how much the actual performance of the portfolio deviates from what the benchmark would have produced. In practice, it’s often quantified as the standard deviation of the differences between the portfolio’s returns and the benchmark’s returns over a given period. A small tracking error means the portfolio tracks the benchmark closely, while a larger tracking error indicates greater divergence, which can arise from active decisions, fees, or sampling methods. This concept is distinct from the volatility of a single stock, the correlation between unrelated assets, or the difference between gross and net returns after fees.

Tracking error is the measure of how closely a portfolio's returns follow its benchmark. It captures how much the actual performance of the portfolio deviates from what the benchmark would have produced. In practice, it’s often quantified as the standard deviation of the differences between the portfolio’s returns and the benchmark’s returns over a given period. A small tracking error means the portfolio tracks the benchmark closely, while a larger tracking error indicates greater divergence, which can arise from active decisions, fees, or sampling methods. This concept is distinct from the volatility of a single stock, the correlation between unrelated assets, or the difference between gross and net returns after fees.