Definition Of Tracking Error
Contents |
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. The first is to subtract the benchmark's cumulative returns from the portfolio's returns, definition information ratio as follows: Returnp - Returni = Tracking Error Where: p = portfolio i =
Definition Sharpe Ratio
index or benchmark However, the second way is more common, which is to calculate the standard deviation of the difference in definition alpha the the portfolio and benchmark returns over time. The 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, definition beta 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 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
Definition R Squared
(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, investment style, and other fundamental characteristics of the portfolio and the benchmark 3. Differences in the weighting of assets between the portfolio and the benchmark 4. The management fees, custodial fees, brokerage costs and other expenses affecting the portfolio that don't affect the benchmark 5. The volatility of the benchmark 6. The portfolio's beta Further, portfolio managers must accommodate inflows and outflows of cash from investors, which forces them to rebalance their portfolios from time to time. This to
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. The first is to subtract the benchmark's cumulative returns from the portfolio's returns, as follows: Returnp definition standard deviation - Returni = Tracking Error Where: p = portfolio i = index or benchmark However, how to calculate tracking error the second way is more common, which is to calculate the standard deviation of the difference in the the portfolio and benchmark
High Tracking Error
returns over time. The 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 http://www.investinganswers.com/financial-dictionary/mutual-funds-etfs/tracking-error-4970 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 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 http://www.investinganswers.com/financial-dictionary/mutual-funds-etfs/tracking-error-4970 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, investment style, and other fundamental characteristics of the portfolio and the benchmark 3. Differences in the weighting of assets between the portfolio and the benchmark 4. The management fees, custodial fees, brokerage costs and other expenses affecting the portfolio that don't affect the benchmark 5. The volatility of the benchmark 6. The portfolio's beta Further, portfolio managers must accommodate inflows and outflows of cash from investors, which forces them to rebalance their portfolios from time to time. This too involves direct and indirect costs. Why it Matters: Low tracking error means a portfolio is closely following its benchmark. High
& Pans E-Newsletter Fund Spy Column Fund Spy Book Bond Squad Fund Video Reports FundInvestor Newsletter ETF Investing Fund Family Experts Fund Reports All http://www.morningstar.com/InvGlossary/tracking_error_definition_what_is.aspx Fund Analyst Reports Fund Stewardship Reports Fund Ratings Highest-Rated Value Highest-Rated Growth Highest-Rated Large-Cap Highest-Rated Mid-Cap Highest-Rated Small-Cap Foreign Fund Standouts Star Rating Performance Rating Methodology Fund Performance Top 1-Month Performers Top YTD Performers Top 1-Year Performers Top 3-Year Performers Top 5-Year Performers Fund Category Returns Biggest Daily NAV Changes Closed-End Funds Exchange-Traded Funds Quarterly Market Outlook Fund tracking error Screeners Basic Screeners Fund Screener Long-Term Winners Solid Small-Growth Funds Conservative Bond Funds Premium Screeners Premium Fund Screener Index Funds Hidden Gems Lower-Risk Foreign Funds Video Center # A B C D E F G H I J K L M N O P Q R S T U V W X Y Z E-mail Article | Print definition of tracking Article | digg it | Del.icio.us http%3a%2f%2fwww.morningstar.com%2fInvGlossary%2fGlossary.aspx%3fterm%3dtracking_error_definition_what_is Tracking Error When using an indexing or any other benchmarking strategy, the amount by which the performance of the portfolio differed from that of the benchmark. In reality, no indexing strategy can perfectly match the performance of the index or benchmark, and the tracking error quantifies the degree to which the strategy differed from the index or benchmark. Sponsors Center Sponsored Links Related Tracking Error Terms 52-Week Range American Stock Exchange Annual High Annual Low Ask Price Related Tracking Error Content The Best New ETFs of 2007 Three Fund Picks with Something Extra A Better Way to Measure Fund Performance? Three Questions to Ask Your Index Fund Related Tracking Error Tools Investment Radar Portfolio Manager Stock Screener Site Directory Site Map Our Products Corrections Help Advertising Opportunities Licensing Opportunities Glossary RSS Mobile Portfolio Affiliate Careers Company News International Sites: Australia Canada China France Germany Hong Kong Italy The Netherlands Norway Spain U.K. Switzerland India Finland Stocks by: Name| Ticker| Star Rating| Market C