Calculate Tracking Error Bloomberg
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Calculate Tracking Error From Monthly Returns
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ETF.com Events All Events Awards Dinner ETF Live ETF University Inside Fixed Income Inside Smart Beta Inside ETFs Inside ETFs Europe Webinars ETF University ETF Guides ETF University Menu About About Us Careers Advertise Reprints Subscribe Contact https://www.bloomberg.com/professional/portfolio-risk-analytics/ Us Legal Info Terms of Service SEARCH Login/Register Home / Features and News / False Tracking Error = Bad ETF Decisions False Tracking Error = Bad ETF Decisions October 24, 2012 Dave Nadig Tracking error tells you everything you need to know about how well your ETF is run, right? Think again. Here’s how I know the ETF Revolution has long since passed, and what we’re living in now is the new ETF normal: The http://www.etf.com/sections/features/14899-false-tracking-error--bad-etf-decisions.html?nopaging=1 questions from advisors are getting a lot smarter. I used to get emails about how creation and redemption worked. Now I get questions about tracking error. Unfortunately, most people think about tracking error all wrong. Here’s a perfect example. Take two funds that have been in the headlines a lot these past few weeks, the Vanguard MSCI Emerging Markets ETF (NYSEArca: VWO) and the iShares MSCI Emerging Markets Index Fund (NYSEArca: EEM). Now imagine you’re a Sophisticated Investor. You know a few things: You know expense ratio matters. You know spreads matter. You know tracking error matters. So you pop up your Bloomberg, and here’s what you see: EEM VWO Expense Ratio 67 bps 22 bps Average Spread ~2 bps ~2 bps Tracking Error .602% 4.433% Even on trading, Vanguard wins on expenses. But Holy Meatballs Batman, what are those guys down in Pennsylvania doing!? A tracking error of 4.433 percent? And at this point, many advisors will make a critical mistake, assuming that the Vanguard fund is horribly mismanaged. It’s not an unreasonable assumption, if in fact this was an accurate tracking error number. But it’s not. Remember, academic tracking error is the annualized standard deviation of daily return differences. If the index is up 1 percent today, and VWO is up 0.95 percent, well, that’s -.05 percent to add to the ser
it indicates how closely a portfolio follows the index to which it is benchmarked. The best measure is the standard deviation of the difference between the portfolio and index returns. Many portfolios are managed https://en.wikipedia.org/wiki/Tracking_error to a benchmark, typically an index. Some portfolios are expected to replicate, before trading and other costs, the returns of an index exactly (e.g., an index fund), while others are expected to 'actively manage' the portfolio by deviating slightly from the index in order to generate active returns. Tracking error is a measure of the deviation from the benchmark; the aforementioned index fund would have a tracking error close to zero, while an tracking error actively managed portfolio would normally have a higher tracking error. Thus the tracking error does not include any risk (return) that is merely a function of the market's movement. In addition to risk (return) from specific stock selection or industry and factor "bets," it can also include risk (return) from market timing decisions. Dividing portfolio active return by portfolio tracking error gives the information ratio, which is a risk adjusted performance measure. Contents 1 calculate tracking error Definition 1.1 Formulas 1.2 Interpretation 2 Examples 3 References 4 External links Definition[edit] If tracking error is measured historically, it is called 'realized' or 'ex post' tracking error. If a model is used to predict tracking error, it is called 'ex ante' tracking error. Ex-post tracking error is more useful for reporting performance, whereas ex-ante tracking error is generally used by portfolio managers to control risk. Various types of ex-ante tracking error models exist, from simple equity models which use beta as a primary determinant to more complicated multi-factor fixed income models. In a factor model of a portfolio, the non-systematic risk (i.e., the standard deviation of the residuals) is called "tracking error" in the investment field. The latter way to compute the tracking error complements the formulas below but results can vary (sometimes by a factor of 2). Formulas[edit] The ex-post tracking error formula is the standard deviation of the active returns, given by: T E = ω = Var ( r p − r b ) = E [ ( r p − r b ) 2 ] − ( E [ r p − r b ] ) 2 {\displaystyle TE=\omega ={\sqrt {\operatorname {Var} (r_{p}-r_{b})}}={\sqrt {{E}[(r_{p}-r_{b})^{2}]-({E}[r_{p}-r_{b}])^{2}}}} where rp−rb is the active return, i.e., the difference between the portfolio return and the benchmark return. Interpret
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