Calculation Of Tracking Error
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the benchmark or index it was meant to mimic or beat. Tracking error is sometimes called active risk. There are two ways to measure tracking error. calculation sharpe ratio The first is to subtract the benchmark's cumulative returns from the
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portfolio's returns, as follows: Returnp - Returni = Tracking Error Where: p = portfolio i = index or
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benchmark However, the second way is more common, which is to calculate the standard deviation of the difference in the the portfolio and benchmark returns over time. The
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formula is as follows: How it works (Example): Let's assume you invest in the XYZ Company mutual fund, which exists to replicate the Russell 2000 index, both in composition and in returns. If the XYZ Company mutual fund returns 5.5% in a year but the Russell 2000 (the benchmark) returns 5.0%, then using the first formula above, we calculation standard deviation would say that the XYZ Company mutual fund had a 0.5% tracking error. As time goes by, there will be more periods during which we can compare returns. This is where the second formula becomes more useful. The consistency (or inconsistency) of the "spreads" between the portfolio's returns and the benchmark's returns is what allows analysts to try to predict the portfolio's future performance. If, for example, we knew that the portfolio's annual returns were 0.4% higher than the benchmark 67% of the time during the last five years, we would know that this would probably be the case going forward (assuming the portfolio manager made no major changes). The predictive value of these calculations gets even better when there are more data points and when the analyst accounts for how the portfolio's securities move relative to one another (this is called co-variance). Several factors generally determine a portfolio's tracking error: 1. The degree to which the portfolio and the benchmark have securities in common 2. Differences in market capitalization, timing, inve
Finance Trading Q4 Special Report Small Business Back to School Reference Dictionary Term Of The Day Martingale System A money calculation of tracking error in excel management system of investing in which the dollar values of investments tracking error definition ... Read More » Latest Videos Why Create a Financial Plan? John McAfee on the IoT how to measure tracking error & Secure Smartphones Guides Stock Basics Economics Basics Options Basics Exam Prep Series 7 Exam CFA Level 1 Series 65 Exam Simulator Stock http://www.investinganswers.com/financial-dictionary/mutual-funds-etfs/tracking-error-4970 Simulator Trade with a starting balance of $100,000 and zero risk! FX Trader Trade the Forex market risk free using our free Forex trading simulator. Advisor Insights Newsletters Site Log In Advisor Insights Log In Tracking Error Loading the player... What is a 'Tracking Error' Tracking error is the http://www.investopedia.com/terms/t/trackingerror.asp divergence between the price behavior of a position or a portfolio and the price behavior of a benchmark. This is often in the context of a hedge or mutual fund that did not work as effectively as intended, creating an unexpected profit or loss instead.Tracking error is reported as a standard deviation percentage difference, which reports the difference between the return an investor receives and that of the benchmark he was attempting to imitate. BREAKING DOWN 'Tracking Error' Since portfolio risk is often measured against a benchmark, tracking error is a commonly used metric to gauge how well an investment is performing. Tracking error shows an investment's consistency versus a benchmark over a given period of time. Even portfolios that are perfectly indexed against a benchmark behave differently than the benchmark, even though this difference on a day-to-day, quarter-to-quarter or year-to-year basis may be ever so slight. Tracking error is used to quantify this difference.Calculation of Tracking ErrorTracking error is the standard deviation of the difference between the returns of an investment and its benc
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 https://en.wikipedia.org/wiki/Tracking_error managed 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 tracking error zero, while an 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 calculation of tracking adjusted performance measure. Contents 1 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 differenc
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