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I believe that this (and Morgan Stanley, from whence the numbers come) misrepresent tracking error.
Here's a short article - with a pretty picture, for those who like graphs from iShares describing the difference between tracking error and tracking difference. The former is the volatility (standard deviation) of the difference between the investment performance and the benchmark performance.
See also Vanguard's discussion of excess return (tracking difference) and tracking error.
It is a common error to conflate the two. A fund that tracks a benchmark perfectly before including expenses would also track a benchmark perfectly after expenses - assuming expenses were constant, because then the underperformance of the fund would be constant (volatility = 0). But the tracking difference would be equal to the fund expenses, so the larger the expenses, the greater the tracking difference (assuming perfect tracking).
Morgan Stanley writes: "the most common sources of tracking error include fees and expenses, portfolio optimization, ...". Emphasis added. So it seems pretty clear that these figures represent tracking differences, not tracking error.
Personally, I prefer Vanguard for indexes because it uses a variety of techniques to reduce tracking differences (i.e. it reduces the drag of fund expenses). In doing so, it almost surely increases tracking error. I don't care - I want performance, not idealized tracking, even from an index fund.
Comments
Here's a short article - with a pretty picture
See also Vanguard's discussion of excess return (tracking difference) and tracking error.
It is a common error to conflate the two. A fund that tracks a benchmark perfectly before including expenses would also track a benchmark perfectly after expenses - assuming expenses were constant, because then the underperformance of the fund would be constant (volatility = 0). But the tracking difference would be equal to the fund expenses, so the larger the expenses, the greater the tracking difference (assuming perfect tracking).
Morgan Stanley writes: "the most common sources of tracking error include fees and expenses, portfolio optimization, ...". Emphasis added. So it seems pretty clear that these figures represent tracking differences, not tracking error.
Personally, I prefer Vanguard for indexes because it uses a variety of techniques to reduce tracking differences (i.e. it reduces the drag of fund expenses). In doing so, it almost surely increases tracking error. I don't care - I want performance, not idealized tracking, even from an index fund.