Tracking error
The standard deviation of a fund's return differences against its benchmark. For an index fund, low tracking error means tight replication; for an active fund, high tracking error means more active risk relative to benchmark.
Tracking error is the standard deviation of the fund's return-versus-benchmark differential, measured period by period over a window. It quantifies how closely a fund's return path tracks its stated benchmark.
For an index fund (a passive product designed to replicate a published index), tracking error should be low — typical NZ-listed index funds report annualised tracking error in the range of 0.10–0.50%, reflecting fee drag, dividend timing, and small replication imperfections. Higher tracking error in a fund marketed as "index" suggests material sampling, sub-index optimisation, or fee impact.
For an active fund, tracking error is a measure of active risk — the amount the manager has deviated from the benchmark to chase performance. Active managers typically run tracking error of 3–8% p.a. against an equity benchmark; concentrated stockpickers can run 10% or more.
Related terms
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index-vs-active
Index fund vs active fund
An index fund mechanically tracks a published market index. An active fund's manager makes discretionary buy/sell decisions trying to beat or differ from a benchmark.
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volatility · σ
Standard deviation (volatility)
The statistical measure of how widely a fund's returns vary around their average. The input to the FMA risk indicator: weekly returns over five years, mapped to a 1–7 band.