Thursday, December 23, 2010

Tracking Error

Tracking error is a measure of how closely a fund's performance follows that of the relevant benchmark or index. The metric is important to those who refer to a benchmark in their mandate. Typically an active manager will have a larger tracking error as, by definition, they should hold different stocks than those which comprise the index, or at leas in different proportions. However an active manager with a lower tracking error may be more consistent in their performance. The tracking error can be calculated by determining the standard deviation of returns relative to the benchmark. Tracking error is best interacted with excess returns to generate the Information Ratio, which provides a suitable basis for manager performance analysis.

Synonyms:  Information ratio, Performance relative to benchmark

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