What is a tracking error?
A tracking error is the difference in amount between an investment portfolio and the benchmark or index against which it’s measured. In reality, tracking errors almost always occur because it’s impossible to perfectly match the performance of a benchmark.
Where have you heard about tracking errors?
If you have a managed portfolio, tracking errors can show you how well it’s being looked after, as well as casting light on market volatility. Low tracking errors mean a portfolio is closely following its benchmark, while high tracking errors indicate the opposite.
What you need to know about tracking errors.
It’s important to note that for some benchmarked portfolios it's more acceptable to have tracking errors than others. While some portfolios are intended to fully replicate a benchmark, others are simply aiming to reflect the spirit of the benchmark.
A passively managed investment such as an index fund should have a low error rate because it seeks to replicate a stock index. On the other hand, actively managed portfolios try to beat benchmark returns, so generally need more risk and expertise to do so. In such cases, the tracking error should be high.
Find out more about tracking errors.
Read our definitions of index fund and active management.