NorthPeak Asset Management runs an active U.S. large-cap portfolio benchmarked to the S&P 500. The CIO wants to know whether the portfolio manager is staying within the fund's stated active-risk budget.
Tracking error measures how much a portfolio's returns deviate from its benchmark's returns. Using the monthly return data below, determine the portfolio's realized tracking error and assess whether it exceeds the fund's annual tracking-error limit of 4.0%.
| Month | Portfolio Return | Benchmark Return | Active Return |
|---|---|---|---|
| 1 | 1.80% | 1.20% | 0.60% |
| 2 | -0.40% | 0.10% | -0.50% |
| 3 | 2.30% | 1.90% | 0.40% |
| 4 | 0.70% | 0.90% | -0.20% |
| 5 | -1.10% | -0.80% | -0.30% |
| 6 | 1.40% | 1.00% | 0.40% |
| 7 | 0.90% | 0.50% | 0.40% |
| 8 | -0.60% | -0.20% | -0.40% |
| 9 | 1.10% | 0.70% | 0.40% |
| 10 | 0.30% | 0.60% | -0.30% |
| 11 | 1.90% | 1.30% | 0.60% |
| 12 | -0.20% | 0.10% | -0.30% |
The fund's mandate states: