How Much Error Is in the Tracking Error: The Impact of Estimation Risk on Fund Tracking Error

摘要

If you are engaged in fund performance measurement and analysis, you are well aware of the influence that biases and noise-induced statistical errors have on expected excess returns and tracking error. Artemiza Woodgate and Andrew Siegel introduce a formula that reduces the influence of biases and noise. In this report, Woodgate explains that the key to their approach is not relying on assumptions about unknown parameters.1.Beware overly optimistic projections. Flawed estimates of expected excess returns and tracking error lead to over-optimistic projections for performance.2.Cut through the noise. Portfolio performance can be projected more accurately by making several adjustments in the methodology for handling noise in the returns.3.Expect higher transaction costs. In these adjusted portfolios, rebalancing occurs less often, but in greater size. The result is a slight increase in transaction costs.