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.