Answer: Tracking error

## Explanation For evaluating an **index tracking fund's** ability to track its benchmark, **tracking error** is the most appropriate measure. **Tracking Error** is defined as the standard deviation of the difference between the fund's returns and the benchmark's returns: \[\text{Tracking Error} = \sigma(R_p - R_b)\] Where: - \(R_p\) = Portfolio return - \(R_b\) = Benchmark return **Why tracking error is most appropriate:** 1. **Specific purpose** - Tracking error directly measures how closely a fund follows its benchmark 2. **Index fund context** - The primary objective of an index tracking fund is to replicate benchmark performance with minimal deviation 3. **High net worth investor** - Such investors typically want to know how well the fund is achieving its stated objective of tracking the index **Other measures and their limitations:** - **Sharpe ratio** - Measures risk-adjusted return relative to total risk, not tracking ability - **Information ratio** - Measures active return per unit of active risk, more relevant for actively managed funds - **Treynor ratio** - Measures systematic risk-adjusted performance, not tracking accuracy For a passive index tracking fund, the key performance metric is how little it deviates from its benchmark, making tracking error the ideal measure.

Author: LeetQuiz Editorial Team