Glossary term
Tracking Error
The standard deviation of the difference between an ETF’s returns and its index’s returns, usually measured on daily or monthly data and annualised. It says how steadily a fund follows its index, not how much of the index’s return it delivered; that is the tracking difference.
AI-generated — produced automatically by Closelook’s systems under this site’s editorial policy.
What it means
Tracking error is a volatility number. Take the fund’s return minus the index’s return for each day or month, then take the standard deviation of that series and annualise it. A fund with a tracking error of 0.10% wanders very little around its index; one at 2% follows loosely. Physical funds that hold every constituent sit near zero; funds that sample, hold illiquid markets, or trade in a different time zone from their index sit higher.
What it does not say
Tracking error does not tell you whether the fund lagged or beat the index. A fund that loses exactly 0.20% to its index every year has a large tracking difference and a tracking error of almost nothing. The two numbers answer different questions: tracking error asks how noisy, tracking difference asks how much. Both belong on a fund’s page; only the second one is a cost.
How Closelook uses it
Closelook reads tracking error as a quality signal on the fund’s replication, next to the tracking difference as the cost signal. It also appears in the information ratio, where active return is divided by tracking error to grade a manager who is meant to deviate from the benchmark.
Common questions
- What is a good tracking error for an ETF?
- Fully replicating funds on liquid indices typically show well under 0.5% a year. Sampled funds, emerging-market funds and funds whose index closes in another time zone run higher. Compare within the same index, not across asset classes.
- Can a fund have a low tracking error and a high tracking difference?
- Yes. If the fund lags by a steady amount, the gap barely varies, so the tracking error is tiny while the tracking difference is the full lag. That is why the difference, not the error, is the cost number.