Is your index fund quoting high tracking error?

An index fund or an ETF’s goal is to track its benchmark index as closely as possible. But cash levels, large inflows and outflows, and expense ratios can lead to a difference in their performances. This variance is measured by a statistic called the tracking error.

The lower the tracking error, the better the passive fund. Typically, it is lesser in schemes tracking large-cap and liquid stocks, compared to their illiquid small-cap counterparts. It is also typically lower in ETFs than in index funds.