Understanding Tracking Error in Passive Equity Investing

Easy Passive Equity Investing Tracking Error

In passive equity investing, tracking error is a critical concept that measures how closely a portfolio follows the performance of a benchmark index. A lower tracking error indicates that the portfolio's performance is more aligned with the benchmark. An investor is examining two passive equity funds, Fund A and Fund B. Fund A has a tracking error of 0.5%, while Fund B has a tracking error of 2.0%. Based on this information, which of the following statements is true regarding the tracking error of these funds?

Fund A is more likely to outperform its benchmark compared to Fund B.

Fund B is expected to perform more closely to its benchmark than Fund A.

Fund A is less risky in terms of deviation from benchmark performance compared to Fund B.

Hint

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