What is tracking error?
Tracking error is the difference between the returns of a fund and the returns of the index that it attempts to duplicate. This tracking error arises primarily because of the forces of supply and demand that determine market prices for these funds. The other type of tracking error, although less relevant to the investors as it does not influence fund performance, is the difference between the net asset value of the index ETF and the underlying index. This difference may arise due to product fees, difference in dividend handling and differences in index composition.
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