What is a good tracking error?

Theoretically, an index fund should have a tracking error of zero relative to its benchmark. Enhanced index funds typically have tracking errors in the 1%-2% range. Most traditional active managers have tracking errors around 4%-7%.

What is tracking error of a portfolio?

Tracking error, also known as active risk, measures, in standard deviation, the fluctuation of returns of a portfolio relative to the fluctuation of returns of a reference index. It is a measure of the risk in an investment portfolio arising from active management decisions made by the portfolio manager.

What is tracking error of ETF?

In the world of ETFs, tracking errors refer to the difference between the actual returns of the fund and the returns of the benchmark index it has its underlying stocks in. Since these funds mirror the performance of the stocks on a particular index, the values of the fund and the index are almost the same.

What creates tracking error?

key takeaways. The difference between the returns of the index fund and its benchmark index is known as a fund’s tracking error. SEC diversification rules, fund fees, and securities lending can all cause tracking errors. Tracking errors tend to be small, but they can still adversely affect your returns.

What does a tracking error of 1 mean?

So, for example, we could say a portfolio has a tracking error relative to its benchmark of 1% per year. For a portfolio with a normal distribution of excess returns and an annualized tracking error of 1%, we would expect its return to be within 1% of its benchmark return approximately two out of every three years.

What is predicted tracking error?

The tracking error predictions of risk models are swayed by recent market conditions. These predictions change significantly depending on the time period of measurement and do not properly capture the absolute level of a portfolio’s active risk.

What is a good information ratio?

The higher the information ratio, the better. Generally speaking, an information ratio in the 0.40-0.60 range is considered quite good. Information ratios of 1.00 for long periods of time are rare.

Can tracking error negative?

Tracking difference, which can be positive or negative, tells you the extent to which a fund has out- or underperformed its benchmark index. Because a fund’s NAV total return includes fund expenses, tracking difference typically is negative for index funds.

Is active risk tracking error?

Tracking error, as active risk is more commonly called, measures the volatility of active returns. Both tracking error and absolute volatility are measured in units of standard deviation. At Commonfund, we use a range of risk measures including volatility, value-at-risk, expected shortfall and maximum drawdown.

How do you interpret ex ante tracking error?

A realized (also known as “ex post”) tracking error is calculated using historical returns. A tracking error whose calculations are based on some forecasting model is called an “ex ante” tracking error. Low errors indicate that the performance of the portfolio is close to the performance of the benchmark.

Is tracking error the same as Alpha?

The answer is not simple. The perception is that tracking error (standard deviation of Alpha) is a measure of Alpha risk. It is assumed that more return can only be earned through more risk and that lower tracking error is a recipe for lower Alpha.

What is a bad information ratio?

If the information ratio of a mutual fund is negative, it indicates that the mutual fund manager was unable to produce any excess returns at all. An information ratio of less than 0.4 means that the mutual fund could not produce excess returns for a sufficiently long time and the fund may not be a good investment.

What does tracking error mean for an investment?

From an investor’s point of view, tracking error can be used to evaluate portfolio managers. If a manager is realizing low average returns and has a large tracking error, it is a sign that there is something significantly wrong with that investment and that the investor should most likely find a replacement.

How does index fund work and how does tracking error work?

The fund manager buys stocks or assets that mimic the performance of the components of the index. The index sampling technique has the risk of a tracking error. A tracking error is the difference between the net asset value ( NAV) of the fund’s holdings and the performance of the benchmark index over time.

How does the stock simulator work on Investopedia?

The Investopedia Stock Simulator is well integrated with the site’s familiar educational content. Using real data from the markets, the trading occurs in context of a game, which can involve joining an existing game or the creation of a custom game that allows the user to configure the rules.

Why is it important to know about ETF tracking errors?

Although rarely considered by the average investor, tracking errors can have an unexpected material effect on an investor’s returns. It is important to investigate this aspect of any ETF index fund before committing any money to it. The goal of an ETF index fund is to track a specific market index, often referred to as the fund’s target index.