Tracking error: Ex ante versus ex post measures

Abstract

In this paper we show that ex ante and ex post tracking errors must necessarily differ, since portfolio weights are ex post stochastic in nature. In particular, ex post tracking error is always larger than ex ante tracking error. Our results imply that fund managers always have a higher ex post tracking error than their planned tracking error, and thus unless our results are considered, any performance fee based on ex post tracking error is unfavourable to fund managers.