Measuring performance
Tracking error
How much a portfolio’s returns deviate from its benchmark, measured as the volatility of the difference.
How it works
A pure index fund aims for near-zero tracking error. An active manager necessarily has a positive one — deviating from the index is the only way to beat it.
It measures how different a portfolio is, not how good. High tracking error with negative alpha simply means being wrong in an unusual way.
Where it misleads people
A tracker with unexpectedly high tracking error is usually revealing a hidden cost or a sampling method, not skill. It is the first number to check when an index fund underperforms its index.
Formula
Tracking error = standard deviation of (portfolio return − benchmark return)Related terms
- BenchmarkThe index or reference portfolio you measure yourself against, to see whether your decisions added anything.
- Index fundA fund that aims to match an index rather than beat it, at very low cost.
- Information ratioExcess return over a benchmark, divided by tracking error — the consistency of outperformance.
- Active shareHow much a fund’s holdings differ from its benchmark, as a percentage.
- Tracking differenceThe plain gap between a fund’s return and its index’s return over a period.
Mentioned in
More in Measuring performance
- Unrealised profit and loss
- Yield on cost
- Total return
- Annualised
- Time-weighted return
- Backtest
- Survivorship bias
- Behaviour gap
All 29 Measuring performance terms · The full glossary, 433 terms
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