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tracking difference

The gap between a fund's return and its index's return over a period; it shows the real cost better than the headline fee.

Tracking difference is how far a fund's return ended up from the return of the index it follows, over a set period, usually a year. If the index gained 6.00% and the fund gained 5.75%, the tracking difference is −0.25%. Factsheets and fund comparison sites often show it next to the ongoing charge, and it answers a simple question: what did holding this fund actually cost compared with the index?

The ongoing charge (often called TER or OCF) is only one part of it. Trading costs inside the fund, cash the fund keeps on hand, tax withheld on dividends and income from lending out securities all move the result. So the tracking difference can be worse than the fee, close to it, or now and then slightly better. A negative number about the size of the fee is normal; a gap much bigger than the fee is worth a question.

Don't confuse it with tracking error, which measures how much that gap jumps around from month to month. For a long-term holder, the average gap over several years matters more than any single year's number.

Example

Grace reads three of Zapas's fictional factsheets. Zapas World Stock charges 0.20% and its tracking difference is −0.25%. Halden World Index charges 0.05%, with −0.06%. Robo Theme charges 0.65%, with −0.75%.

If the Tessaro World index rose 6.00% in a year, Zapas World Stock would deliver about 6.00% − 0.25% = 5.75%. On $10,000 that's about $25 less than the index, not the $20 the fee alone suggests. So in the all-in comparison Grace uses the tracking difference, not the fee, as the cost inside the fund. Fictional funds, for learning only.

Common mistakes

  • Comparing funds by the headline fee only.
  • Judging a fund on a single year; look at several years.
  • Mixing up tracking difference (the average gap) with tracking error (how much the gap varies).
  • Forgetting the costs outside the fund: spread, currency conversion and platform fees aren't in the tracking difference.

Learn it in the course