What is the average tracking error also known as?

The average tracking error is known as active risk because it measures how much the returns of a portfolio deviate from the returns of a benchmark index. This deviation is an indication of how actively managed a portfolio is in comparison to its benchmark.

Active risk plays a vital role in assessing the performance of an investment strategy, particularly for actively managed funds, as it quantifies the risk taken relative to a benchmark. A higher active risk indicates that the portfolio manager is making significant deviations from the benchmark, which could lead to higher rewards or losses compared to simply tracking the index.

In contrast, portfolio risk is a broader term that includes all risks associated with a specific portfolio, not just those attributable to the active management strategies. Market risk and systematic risk refer to the inherent risks affecting the entire market or specific categories of assets that cannot be mitigated through diversification. Thus, their definitions do not align with what tracking error measures, which is specifically tied to the performance relative to a chosen benchmark.