Tracking Error

Tracking error measures how closely an investment portfolio follows the index to which it is benchmarked.

Many portfolios are managed to a benchmark, usually an index such as the NSE 50, Bank Nifty, and Nifty Financial Services. Some portfolios are expected to replicate, before trading and other costs, the returns of an index exactly called an index tracker fund. In contrast, others are expected to be actively managed by a fund manager by deviating slightly from the index to generate active returns or lower transaction costs.

Tracking error is a measure of the deviation from the benchmark. For example, an index fund would have a tracking error close to zero, while an actively managed portfolio would typically have a higher tracking error.