Tracking error is the difference between the returns of a mutual fund and the returns of its benchmark index. It shows how much a fund's performance has moved away from the index it is supposed to copy. This is mostly used for index funds and ETFs, where the goal is to match the benchmark exactly.

Why Is Tracking Error Important in Mutual Funds?

Tracking error is important because it shows how well an index fund is managed. The main aim of index funds is to match the benchmark. If tracking error is high, it means the fund is not doing a good job of following the index. Low tracking error means the fund is consistent and reliable in tracking its benchmark.

How Is Tracking Error Calculated?

Tracking error is calculated by measuring the standard deviation of the difference between the daily returns of the fund and the benchmark. In simple words, it checks how much the fund’s returns are moving away from the index on average. The lower the number, the better the fund is at following its benchmark.

What Are the Reasons for High Tracking Error?

High tracking error can happen due to many reasons like fund manager’s strategy, cash holdings, expense ratio, transaction costs, or delay in buying and selling the stocks. Sometimes, market volatility and dividend payout timings also create gaps between the fund and the index performance.

How to Find Tracking Error of a Mutual Fund?

You can find the tracking error of a mutual fund on the fund’s fact sheet, AMC websites, or platforms like Angel One. It is usually mentioned as a percentage. Lower tracking error means the fund is doing a better job of following the benchmark index closely. This is one of the key things to check while selecting index funds.

How to Use Tracking Error to Choose Better Index Funds?

When selecting index funds, always compare the tracking error. Choose the fund with lower tracking error and a reasonable expense ratio. A fund with low tracking error means it’s managed well and is better at delivering returns similar to the index. This helps you make a more informed and smart investment decision.