ETF | What is the tracking error volatility

A concept of extreme importance in the context of the ETF is the tracking error volatility also expressed by the acronym TEV. It is an indicator that measures when the average daily returns of the ETFs differ from those of the underlying index or benchmark. ETFs are clones if they are efficient and therefore do not have to travel independently, but closely track the evolution and the performance of the underlying index. Sometimes the manager attempts to beat the benchmark with strategies such as overweight or underweight certain securities and then this difference can increase in both negative and positive ways.

Tracking Error Volatility

Tracking Error Volatility

If TEV has a high value, it indicates that the management of the investment fund is active. If it has a low value, this indicator shows a passively managed ETF.

One way to check if an ETF is well managed is to see if the TEV does not exceed the TER (total expense ratio) which we have already spoken about.

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