Investing tracking error passive funds

Tracking error and tracking difference in passive funds

From WebNotes, a public knowledge base. Last updated 18 May 2026. Reading time ~5 min.

Tracking error measures the volatility of a passive fund’s return deviation from its benchmark index, while tracking difference measures the average return deviation. Both are key quality metrics for index funds and ETFs .

Formulas

Tracking difference = Average (Scheme return - Benchmark return) over period.
Tracking error = Standard deviation of (Scheme return - Benchmark return) over period.

Both are typically expressed as annualised percentages.

Typical ranges

For well-run Indian passive funds:

Product	Tracking Error	Tracking Difference
Nifty 50 Index Fund	0.05-0.30%	-0.10 to -0.40% (negative due to TER)
Nifty 50 ETF	0.02-0.15%	-0.05 to -0.20%
Mid-cap index fund	0.10-0.50%	-0.20 to -0.50%
Bharat Bond ETF	0.05-0.20%	Near zero (low TER)
International funds	0.30-1.50%	Variable

Causes of tracking error

TER: Reduces fund NAV growth versus index.
Cash drag: Small cash holdings reduce equity exposure.
Rebalancing timing: Lag between index rebalance and fund rebalance.
Securities lending revenue: Can offset some costs.
Withholding tax on dividends: For international index funds.

Interpretation

For investors choosing index funds or ETFs:

Lower tracking error is better: Indicates better index replication.
Lower (more negative) tracking difference: Less return drag versus benchmark.
Compare same-index products: Choose lower-tracking-error variant.

Use in fund evaluation

For Nifty 50 Index Funds , check:

Tracking error: How consistently the fund follows the index.
Tracking difference: How much return is given up vs index.
TER: The main cost component affecting tracking difference.

A fund with TER 0.30% and tracking difference -0.35% is performing well (tracking difference close to TER).

A fund with TER 0.30% but tracking difference -1.0% has additional friction (operational issues).

External references

References

CFA Institute curriculum on tracking error.
AMFI passive-fund guidelines.

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The WebNotes Editorial Team covers Indian capital markets, payments infrastructure and retail investor procedures. Every article is fact-checked against primary sources, principally SEBI circulars and master directions, NPCI specifications and the official support documentation published by the intermediary in question. Drafts go through a second-pair-of-eyes review and a separate compliance read before publication, and revisions are tracked against the SEBI and NPCI rule changes referenced in the methodology section.

Last reviewed: 18 May 2026
Conflicts of interest: WebNotes is independent. No relationship with any broker, registrar or bank named in this article.