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What causes tracking error in Index funds?

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Hi @Ashish 16,

Tracking Error is basically the difference between the performance of a stock or a Mutual Fund and its benchmark. The tracking index might tend to be small, but it can cause an adverse impact on your returns. 

The reasons for such error might include SEC Diversification rules, Fund fees, and Securities Lending. 

Moreover, if we compare theory with practicality, the scenario alters a bit. In theory, trades for all the different securities that an investor buys or sells must be executed simultaneously at the current price. It differs in reality though. Many times, the funds' buy and sell transactions might be large enough to slightly change the price of the securities in trading. 

It also depends on the speed of the exchange and the trading volume in each of the security. 

Hope this addresses your query!