Using Tracking Error

This example shows how to use tracking error to measure the variation of a portfolio's return relative to its benchmark index.

Given an asset or portfolio of assets and a benchmark, the relative standard deviation of returns between the asset or portfolio of assets and the benchmark is called tracking error.

The function inforatio computes the tracking error and returns it as a second argument.

load FundMarketCash 
Returns = tick2ret(TestData);
Benchmark = Returns(:,2);
[InfoRatio, TrackingError] = inforatio(Returns, Benchmark)

InfoRatio = 1×3

    0.0432       NaN   -0.0315

TrackingError = 1×3

    0.0187         0    0.0390

Tracking error, also know as active risk, measures the volatility of active returns. Tracking error is a useful measure of performance relative to a benchmark since it is in units of asset returns. For example, the tracking error of 1.87% for the fund relative to the market in this example is reasonable for an actively managed, large-cap value fund.