Understanding Tracking Error in Passive Equity Investing

As an investment analyst, you are tasked to explain the concept of tracking error to a group of new investors considering a passive equity investment strategy. Tracking error is a crucial measure that reflects how closely a portfolio's performance follows the performance of a benchmark index. It is important for investors to understand how tracking error can impact their investment strategy and outcomes.

In your response, define tracking error, explain how it is calculated, and discuss its significance in the context of passive equity investing. Provide examples to enhance your explanation.