Measurement and Decomposition of Tracking Error Variance

An objective approach to distinguish the investment strategies followed by different mutual funds is proposed. Tracking error variance is used as a measure of how actively a fund is managed and several decompositions of tracking error variance are proposed to identify different investment strategies. Furthermore, recognizing that tracking error variance is subject to sampling error, we provide simulated confidence intervals. We perform an empirical analysis with a small selection of U.S. equity funds as well as a simulation study. ∗Swiss Institute of Banking and Finance, Universität St.Gallen, Rosenbergstrasse 52, 9000 St.Gallen, Switzerland. Phone +41 71 224-7062. Fax +41 71 224-7018. Email [email protected], j [email protected]. Manuel Ammann is a lecturer of finance, Jürg Tobler a postdoctoral research fellow at University of St.Gallen. We would like to thank Philipp Halbherr, Karl Keiber, Roger Walder, and seminar participants at University of St.Gallen for helpful comments.