What is tracking error?
Sometimes it is referred to as an active risk, the monitoring error is a situation where there is a difference between the price behavior of a benchmark associated with the asset in the investment portfolio and the behavior of the position associated with the same asset. This type of divergence usually occurs when the hedge fund or mutual fund does not perform a way that was previously expected, resulting in a return that is higher than the projected, or not expected to lose. There are several ways to measure the monitoring error depending on the nature of the benchmark.
One of the more common ways of measurement of monitoring error includes the assessment of the difference between the portfolio and the benchmark yield where the benchmark is associated with the index. This process involves identifying the root diameter of this difference. This process essentially includes Squaring each number associated with yields, then determining the average of these squares and the finals identifying the second diameter square root. This process provides a more accurate rating than simply obtaining the diameter from the appropriateIt makes it easier to determine the exact degree of divergence, which is present between the actual return and the standard or benchmark expected.
The historical data can be used to calculate the tracking error. In the case of this, the result is known as an ex-post error. If the calculation is based on estimates for future returns, the result is known as an ex-ante error. Regardless of the origin of the data, the result can be influenced by such factors such as administration charges and sellers, commercial costs associated with investment and differences in the investment benchmark.
It is not unusual for some small amount of ERROR monitoring to be present with most investments involving mutual funds or hedges. The error may be a loss that the asset did not perform as well as expected. At the same time, an error may also represent an unexpected profit providedthat the real return is greater than the benchmark identified by the investor. Making time to calculate the monitoring error can be instructive because the process can provide the investor with data that can be overlooked by other methods and thus increase the chances that the investment will be carried out at the level of the investor.