Tracking error

The volatility of the difference between a portfolio's returns and its benchmark's.

A portfolio with 6% tracking error deviates 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 cannot deliver much active return, whatever their skill.

It is a constraint on the strategy, not a measure of its quality.