Used Every Day but Widely Misunderstood: Tracking Error
Agenda
Presented by Northfield President Dan diBartolomeo
In traditional asset management, the most widely used metric for portfolio risk is tracking error. Despite the popularity of this form of risk estimate, the concepts behind tracking error are widely misunderstood, leading to inefficient decisions by portfolio managers.
In this presentation, we will discuss the nuances of tracking error as in should (or should not) be applied in various investment funds. The use of tracking error arose out of index funds that were pursuing either full replication or stratified sampling strategies. Over time, use of this estimator spread to active managers in both equities and fixed income as managers became ever more conscious of benchmark relative performance.
Unfortunately, the application of tracking error in active management is widely misunderstood, leading Northfield to develop an alternative measure which we call “active risk,” which is uniformly higher than tracking error with the relationship being non-linear. Other misunderstandings about tracking error include how to compute ex-post tracking error and the extent to which tracking error can be consider a “downside” or worst-case expectation for active return.
About Dan diBartolomeo
Dan diBartolomeo is President and founder of Northfield Information Services, Inc. He is also a former Visiting Professor at the CARISMA Research Center of Brunel University in London and serves on the Board of Directors of the Chicago Quantitative Alliance and the advisory board of the International Association for Quantitative Finance. He is a regional director of the Professional Risk Managers International Association, (PRMIA), and the Quantitative Work Alliance for Applied Finance, Education and Wisdom (QWAFAFEW). He is past president and director of the Boston Economic Club.
Dan has been admitted as an expert witness in US federal courts and state courts for litigation matters regarding investment management practices and derivatives.
In 2010, Dan received an award from Institutional Investor magazine as one of the forty most influential executives in financial technology in connection with his analytical work that helped uncover the Madoff investment fraud.
Dan is a director of the American Computer Foundation, and formerly served on the industry liaison committee of the Department of Statistics and Actuarial Sciences at New Jersey Institute of Technology. He continues his more than twenty years of service as a judge in the Moskowitz Prize competition, given by the University of California at Berkeley for excellence in academic research on socially responsible investing.
Dan has a long list of publications including books, book chapters and research papers in professional journals such as Financial Analyst Journal, Quantitative Finance and Journal of Investing. In 2017, he was named co-editor of the Journal of Asset Management