Techniques for Managing Tracking Error
نویسندگان
چکیده
Managing tracking error on an ex ante basis requires an ability to assess the possible effects of trades on a fund’s performance relative to its benchmark. Given a trading strategy, its potential for reducing tracking error must be balanced against trading costs and return expectations. This chapter presents several simple diagnostic tools to help fund managers evaluate alternative trading strategies in this regard. Specifically, expressing tracking error as a function of the trading strategy allows for the construction of various Trade Risk Profiles (TRPs), which clarify the relationships among tracking error, risk contributions, expected returns and trading activity. Moreover, such profiles can readily incorporate trading restrictions as necessary to ensure an acceptable portfolio structure. An illustrative example demonstrates the practical application of these techniques. In recent years there has been an increased focus on tracking error as the means for measuring and controlling risk in actively managed funds. This is a result of several important investor trends:
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