What is tracking error and why it is important
Mar 25, 04:03

Passive funds are gaining ground. How do you choose one over another? Lower expense ratios are good, but when it comes to picking an index fund or Exchange Traded Fund (ETF), a scheme's Tracking Error (TE) is a better parameter. Since a passive fund's aim is to mimic its benchmark index, the closer it tracks the index, the better it is. This is measured by a scheme's TE; the difference in the performance of the scheme and its index. The lower the TE, the better your passive fund is. Typically, ETFs have lower TEs than index because of their superior structure. TE may increase mainly due to the fees and expenses of the fund, cash balance, changes to the underlying index and regulatory restrictions.

Schemes with least tracking error