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Do tracking errors reliably estimate portfolio risk?

Author

Listed:
  • A Scowcroft

    (UBS Warburg Ltd)

  • J Sefton

    (UBS Warburg Ltd)

Abstract

An active equity investment strategy aims to select a portfolio of stocks that are likely to outperform the market without exposing the investor to unacceptable levels of risks. The purpose of this paper is to assess whether tracking errors have historically accurately quantified these levels of risk in the UK. The results suggest that over the short-term horizons, tracking errors have performed reasonably well, but over the longer-term horizons (>1 year), they have tended to underestimate risk. We find evidence that this underestimation can be explained by a combination of transitory market momentum effects and changes to overall levels of market volatility. We also investigate how investment strategies of sector neutrality reduce levels of portfolio risk.

Suggested Citation

  • A Scowcroft & J Sefton, 2001. "Do tracking errors reliably estimate portfolio risk?," Journal of Asset Management, Palgrave Macmillan, vol. 2(3), pages 205-222, December.
    • Handle: RePEc:pal:assmgt:v:2:y:2001:i:3:d:10.1057_palgrave.jam.2240046
    DOI: 10.1057/palgrave.jam.2240046
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    Cited by:

    1. Luca Riccetti, 2012. "Using tracking error volatility to check active management and fee level of investment funds," Global Business and Economics Review, Inderscience Enterprises Ltd, vol. 14(3), pages 139-158.
    2. Nadima El-Hassan & Paul Kofman, 2003. "Tracking Error and Active Portfolio Management," Australian Journal of Management, Australian School of Business, vol. 28(2), pages 183-207, September.
    3. Riccardo Lucchetti & Mihaela Nicolau & Giulio Palomba & Luca Riccetti, 2022. "Reconciling TEV and VaR in Active Portfolio Management: A New Frontier," Working Papers 461, Universita' Politecnica delle Marche (I), Dipartimento di Scienze Economiche e Sociali.

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