Published Jun 22, 2026 4 Min Read

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Introduction

Tracking difference and tracking error measure different aspects of index fund tracking. Tracking difference shows the gap between fund returns and benchmark returns, while tracking error measures how consistently that gap changes over time.

  • Tracking difference: The return gap between a fund and its benchmark.
  • Tracking error: The volatility or consistency of that return gap.
  • Lower values: Usually indicate better index fund tracking.
  • Common causes: Expense ratios, cash holdings, transaction costs, and portfolio rebalancing.
  • Useful for investors: Both metrics help you evaluate passive fund accuracy before investing.
  • Investment options: The Bajaj Broking website offers access to 4,000+ mutual fund schemes with SIP investments starting from Rs. 100 per month.

You can explore index funds and ETFs on the Bajaj Broking website, complete KYC as required by SEBI regulations, and start investing through SIP or lumpsum modes.

What is tracking difference?

Tracking difference is the difference between the return generated by an index fund or ETF and the return generated by its benchmark index over a specific period.

For example, if a benchmark index delivers a return of 12% in one year and the fund delivers 11.5%, the tracking difference is -0.5%.

A smaller tracking difference usually means the fund has followed its benchmark more closely. Since passive funds aim to replicate an index rather than beat it, investors generally prefer lower tracking differences.

FactorDescription
Benchmark returnReturn generated by the index
Fund returnReturn generated by the fund
Tracking differenceDifference between the two returns
Investor preferenceLower tracking difference

What is tracking error?

Tracking error measures how consistently a fund follows its benchmark over time. It does not measure the return gap itself. Instead, it measures the variation in that gap.

A fund can have a small average tracking difference but still show a high tracking error if its performance fluctuates significantly relative to the benchmark.

A lower tracking error generally indicates more consistent benchmark tracking.

Tracking error levelMeaning
LowFund closely follows the benchmark consistently
ModerateSome variation from benchmark performance
HighLarger and less predictable deviations

How are tracking difference and tracking error different?

Although both metrics assess index fund tracking, they measure different things.

FeatureTracking differenceTracking error
MeasuresReturn gapConsistency of return gap
FocusActual underperformance or outperformanceVolatility of deviations
Expressed asPercentage differenceStandard deviation
Investor useCompare returns with benchmarkAssess tracking consistency

When comparing passive funds, it is helpful to evaluate both metrics together. A fund with low tracking difference and low tracking error is generally considered more efficient at replicating its benchmark.

How are tracking difference and tracking error calculated?

Tracking difference formula

Tracking difference is calculated by subtracting the benchmark return from the fund return.

Tracking Difference = Fund Return − Benchmark Return

Example:

  • Fund return = 10.8%
  • Benchmark return = 11.2%

Tracking Difference = 10.8% − 11.2% = -0.4%

Tracking error formula

Tracking error is calculated using the standard deviation of the differences between fund returns and benchmark returns over a period.

Tracking Error = Standard Deviation of (Fund Return − Benchmark Return)

A lower value indicates the fund has followed the benchmark more consistently.

What causes tracking difference and tracking error?

Several factors can create deviations between a passive fund and its benchmark.

Expense ratio

The AMC charges an expense ratio for managing the fund. Since this cost is deducted from the NAV, it can reduce returns and create tracking difference.

Cash holdings

Funds may keep a small portion of assets in cash to manage redemptions. Cash does not always move in line with the benchmark, which can create deviations.

Transaction costs

Buying and selling securities involves brokerage charges, taxes, and other costs. These can affect fund performance.

Rebalancing delays

Indices periodically change their constituents. Funds may take time to adjust their portfolios, which can lead to temporary differences.

Corporate actions

Dividends, mergers, stock splits, and other corporate events can create short-term variations between a fund and its benchmark.

Conclusion

When comparing tracking difference vs tracking error, remember that they serve different purposes. Tracking difference shows how much a fund's returns differ from its benchmark, while tracking error shows how consistently the fund tracks that benchmark.

For passive fund investors, both metrics matter. A lower tracking difference means returns stay closer to the index, while a lower tracking error suggests more stable replication. Reviewing both measures can help you choose index funds and ETFs that align more closely with their stated benchmark.

Frequently asked questions

What is the difference between tracking difference and tracking error?

Tracking difference vs tracking error refers to two different measures of passive fund accuracy. Tracking difference shows the gap between fund returns and benchmark returns, while tracking error measures the consistency of that gap over time. When reviewing index funds on the Bajaj Broking website, checking both metrics can help you assess ETF benchmark deviation and overall fund efficiency.

What is a good tracking error for an index fund?

A good tracking error is generally a low tracking error because it indicates the fund is closely following its benchmark. There is no single SEBI-prescribed number, but investors usually compare similar funds tracking the same index and prefer those with lower and more consistent tracking errors.

Why does tracking difference occur?

Tracking difference can occur due to expense ratios, transaction costs, cash holdings, rebalancing delays, and corporate actions. Even though passive funds aim to replicate an index, these operational factors can cause the fund's returns to differ slightly from benchmark returns.

Does tracking error affect my actual returns?

Tracking error does not directly measure your returns. Instead, it measures how consistently a fund tracks its benchmark. A high tracking error may indicate larger performance deviations over time, which can affect how closely your investment mirrors the index.

Which is more important: tracking error or tracking difference?

Both are important because they provide different information. Tracking difference tells you how much return you gained or lost relative to the benchmark, while tracking error tells you how stable that relationship has been. On the Bajaj Broking website, evaluating both metrics together can help you make a more informed fund selection decision.

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