Using Tracking Error

Given an asset or portfolio of assets and a benchmark, the relative standard deviation of returns between the asset or portfolio of assets and the benchmark is called tracking error.

The function inforatio computes tracking error and returns it as a second argument

load FundMarketCash 
Returns = tick2ret(TestData);
Benchmark = Returns(:,2);
[InfoRatio, TrackingError] = inforatio(Returns, Benchmark)

which gives the following results:

InfoRatio =
    0.0432       NaN   -0.0315
TrackingError =
    0.0187         0    0.0390

Tracking error, also know as active risk, measures the volatility of active returns. Tracking error is a useful measure of performance relative to a benchmark since it is in units of asset returns. For example, the tracking error of 1.87% for the fund relative to the market in this example is reasonable for an actively managed, large-cap value fund.