What is tracking error? | Value Researchhttps://www.valueresearchonline.com/stories/33791/what-is-tracking-error/Dhirendra Kumar explains what is tracking error and what all reasons may cause it
Transcript: An index fund is always tracking an index. Tracking error happens when the fund is unable to match the index movements. Say, there's an open-end fund that tracks Nifty and it goes up by 90 basis points, while Nifty itself goes up by 1%. The difference would result in tracking error.
It happens due to a number of reasons.
The time when an AMC buys the constituent stocks may not be the same as when it receives the money from the investors. So, allotment of units and actual stocks may sometimes happen at different times, which results in tracking error.
Fund company face redemptions and new purchases every day, i.e., investors buy and sell every day. After aggregating, depending on the net positions, the fund company will buy or sell the underlying stocks. In such a situation, buying and selling may not be of a quantum which will be a round unit. If the fund company has got Rs 6 lakh as one day's inflow or Rs 3 lakh as outflow, it may not be able to replicate the constituents perfectly.
Indices, be it Nifty or Sensex, are not dividend adjusted. But when you buy these shares, you also receive dividends, which may make some difference.
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