Tracking Error

Tracking error is a statistical measure quantifying how closely an ETF's daily performance follows its benchmark. Technically, it is the annualised standard deviation of daily return differences between the ETF and its index. A tracking error of 0.5% means daily performance gaps vary by 0.5% on average — a measure of consistency, not cost.

The formula

Tracking Error = StdDev(ETFReturn − IndexReturn) × √252. Calculate the daily performance difference between ETF and index, then compute the standard deviation of these differences, annualised by multiplying by √252 (trading days per year).

Acceptable tracking error thresholds

For ETFs replicating broad, liquid indices (MSCI World, S&P 500, FTSE 100), a tracking error below 0.5% annualised is considered excellent. Between 0.5% and 1%, replication is acceptable. Above 1%, this may indicate heavy sampling or a difficult-to-replicate index (frontier emerging markets, high-yield bonds).

Tracking Error vs Tracking Difference

Tracking error measures gap volatility (consistency). Tracking difference measures the cumulative gap (total cost). For investors, tracking difference is more useful for assessing real cost, while tracking error is useful for evaluating replication reliability over time.