Tracking Error
The standard deviation of the difference between a portfolio's returns and its benchmark's.
Formula
Tracking Error = Standard Deviation of (Portfolio Return - Benchmark Return) over the period
Unit
%
In depth
Tracking error measures how far a portfolio strays from its benchmark, in either direction, so it describes activeness rather than skill — a manager who deviates a great deal may be very good or very bad. For an index fund it should be as close to zero as costs allow, and a persistently high figure indicates poor replication rather than ambition. For an active fund it is the denominator of the information ratio, and a fund with very low tracking error and high fees is a closet index fund charging for a service it does not deliver. It is distinct from tracking difference, which measures the average gap rather than its variability.
Worked example
An index fund with a 0.35% tracking error is replicating well. An actively managed fund with 0.8% tracking error and a 1.8% expense ratio is deviating too little to justify the fee — it cannot beat the index by enough to cover it.
Illustrative figures, chosen so the arithmetic is easy to follow. Not a live price and not a valuation of any company.
Educational reference only
This entry explains what “Tracking Error” means. It is not investment advice and not a recommendation to buy or sell any security. Any numbers above are illustrative, not live prices, and nothing here predicts price direction or rates a stock. Consider your own circumstances and consult a SEBI-registered investment adviser before acting.