This article highlights an attribute of ex-ante tracking error estimates that is not uniformly appreciated. Risk models’ tracking error predictions are influenced by recent market conditions and change depending upon the time period of measurement. This paper includes a test demonstrating variation in ex-ante tracking error estimates over time. Monitoring predicted tracking error across time does not accurately measure the absolute level of a portfolio’s active risk. Further, imposing ex-ante tracking error limits on portfolios can lead to needless turnover/portfolio restructuring.

Comparing Ex-Ante Tracking Error Estimates Across Time