Glossarytaught in AA1.03
Tracking error
Also called active risk.
The volatility of the difference between a portfolio's returns and its benchmark's.
If your portfolio has 6% tracking error, expect it to deviate from its index by that much in a typical year.
Low tracking error means the portfolio resembles the index, which limits both underperformance and the possibility of outperformance. Managers whose mandates constrain tracking error tightly can't deliver much active return, whatever their skill.
It tells you how tightly the strategy is constrained and says nothing about its quality.