Understanding Tracking Error in Passive Equity Investing

A portfolio manager is responsible for managing a passive equity fund designed to track the performance of a specific index. It is important for the manager to understand how closely the fund's returns align with the index's returns. This alignment is quantified by a metric known as tracking error.

Tracking error measures the standard deviation of the difference between the returns of the fund and the returns of the benchmark index. A lower tracking error indicates closer performance alignment with the index, whereas a higher tracking error suggests greater deviation.

Given this context, consider the following statements regarding tracking error: