Quant · Core
Tracking Error
Tracking error is the volatility of active return versus a benchmark — how much the book is allowed to be not-the-index.
Definition
TE = σ(r_p − r_b), usually annualized. Ex-ante TE is from a risk model; ex-post is realized. Closet indexers run tiny TE; concentrated books run large TE and need an IR that pays for it.
Why it matters
Mandates are written in TE. Information ratio is excess / TE. A fee on a 50bp-TE product is a large haircut on a small residual.
Case
An ‘active’ global equity fund with 1.2% TE and 80bp fees. Clients bought the index plus a coin flip minus fees.
How to read it
Ex-ante vs ex-post, and whether the benchmark matches the universe. TE is a budget, not a virtue.
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