Authors: Israelsen, Craig L; Cogswell, Gary F

Source: Journal of Asset Management, Volume 7, Number 6, March 2007 , pp. 419-424(6)

Publisher: Palgrave Macmillan

Abstract:

As the application of modern portfolio theory has evolved within an equities market increasingly focused on passively managed portfolios, tracking error (ie performance variance from a benchmark index) has emerged as a primary measure for evaluating the performance of managers, where low tracking error is typically viewed as a positive in terms of risk management. Ironically, actively managed mutual funds with low tracking error exhibit lower alpha, higher beta, and lower average performance compared to funds with high tracking error. Ranking funds using the information ratio incorporates tracking error as the denominator (IR=alpha/tracking error). High IR funds demonstrate lower volatility of return, higher alpha, lower beta, and higher returns than funds with low IR. As additional irony, high IR funds demonstrate significantly higher tracking error than low IR funds.Journal of Asset Management (2007) 7, 419-424. doi:10.1057/palgrave.jam.2250051

Document Type: Research article

DOI: http://dx.doi.org/10.1057/palgrave.jam.2250051

Publication date: 2007-03-01

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