The so-called tracking error refers to the deviation between the return rate of index funds and the return rate of the underlying index. Tracking error describes the closeness between the fund and the underlying index according to the historical difference data of the return rate, and reveals the fluctuation characteristics of the fund return rate around the underlying index.
Generally speaking, the accuracy of tracking error is related to the length of observation period. The longer the observation period and the more observation points, the more accurate the calculated tracking error will be. The factors that affect the tracking error of index funds mainly include the influence of fund positions, the change of the underlying index components, the enhanced indexation combination, the calculation of tail difference, the cost of fund assets and so on. Generally speaking, improving the accuracy of tracking the underlying index and reducing the tracking error is the core technology of index investment, and it is also the premise that index fund, an investment tool, can be used for investor asset allocation.