Tracking Error
Tracking Error (TE) is the standard deviation of the difference between a portfolio’s return and its benchmark’s return. It quantifies how closely a fund follows its benchmark. Formula: TE = StdDev(Portfolio return − Benchmark retur
Tracking Error (TE) is the standard deviation of the difference between a portfolio’s return and its benchmark’s return. It quantifies how closely a fund follows its benchmark.
Formula: TE = StdDev(Portfolio return − Benchmark return), annualized.
INR example: A Nifty 50 Index Fund should have TE < 0.10% if well-managed. A Nifty 50 ETF averages TE of 0.05–0.15%. An active large-cap fund has TE in the 3–6% range; a flexicap can hit 5–10%. SEBI mandates passive funds disclose monthly TE in factsheets.
When to use: For passive funds — low TE = good replication. For active funds — TE indicates “active share” (higher TE = manager is taking bigger bets vs benchmark). Combine with Information Ratio to judge if active risk was rewarded.
SEBI note: SEBI Master Circular for Mutual Funds (June 2024) caps tracking difference for Index Funds and ETFs at 1.25% (1-yr rolling average) — chronic breaches require AMC corrective action.
Related terms: Information Ratio, Index Fund, ETF.