Tracking Error

Tracking error is a measure of how closely a portfolio or fund follows the performance of a benchmark index. It is calculated as the standard deviation of the differences between the portfolio’s returns and the benchmark’s returns. A low tracking error indicates that the portfolio closely follows the index, while a high tracking error suggests more divergence. Tracking error is commonly used to evaluate the performance of index funds and other passive investments.

Example

An ETF that aims to replicate the S&P 500 index has a tracking error of 0.5%, meaning its returns have deviated from the index by an average of 0.5% over time.