Term · Portfolio & Execution
Benchmark Tracking Error
In briefThe tracking error measures how strongly a portfolio's return deviates from its benchmark, expressed as the volatility of these relative differences. For small-cap portfolios it shows how far stock selection, liquidity and weighting drift away from the reference index.
Definition
Deviation of a portfolio's return from its benchmark. The tracking error measures the volatility of these relative deviations.
How it is calculated
Formula. Tracking Error = standard deviation(portfolio return − benchmark return).
Why it matters for small caps
For small-cap portfolios it shows how strongly active stock selection, liquidity and weighting deviate from the reference index.
Common misreadings
- A low tracking error does not automatically mean low absolute risks; it only measures proximity to the benchmark.
In the process
Frequently asked
What is the tracking error?
It is a measure of the deviation of the portfolio return from the benchmark. A higher value means greater relative fluctuations.
How is the tracking error calculated?
You form the standard deviation of the difference between portfolio and benchmark return. This gives the fluctuation range of the relative performance.
Does a low tracking error mean low risk?
No, it only measures proximity to the benchmark. It does not capture absolute risks such as market declines.
Related terms
Sources
Primary
Cremers/Petajisto – Originalarbeit zu Active Share
https://papers.ssrn.com/sol3/papers.cfm?abstract\_id=891719
https://papers.ssrn.com/sol3/papers.cfm?abstract\_id=891719
Methodology
MSCI – Small Cap Indexes
https://www.msci.com/indexes/group/small-cap-indexes
https://www.msci.com/indexes/group/small-cap-indexes
Education only, not investment advice. Ranges and thresholds are didactic orientation values, not an official standard.