Tracking Error vs Tracking Difference: SEBI's Definitions

Tracking error vs tracking difference is the pair of numbers that tells you how well an Indian index fund or ETF is doing the one job it has. SEBI defines both in paragraph 4.5.4 of its Master Circular for Mutual Funds dated 20 March 2026 (HO/24/13/11(1)2026-IMD-POD-1/I/7602/2026, issued in line with the SEBI (Mutual Funds) Regulations, 2026, which come into force on 1 April 2026; read on 18 September 2026). Tracking error is the annualised standard deviation of the difference in daily returns between the index and the fund's NAV, measured on one year of rolling data. Tracking difference is the annualised difference of daily returns between the index and the NAV. The first measures how erratic the gap is; the second measures how big it is. SEBI caps tracking error at 2 percent for equity and other non-debt passive funds, caps the one-year average tracking difference at 1.25 percent for debt ones, and requires both figures to be published on the AMC's and AMFI's websites.

What is tracking error vs tracking difference, in SEBI's words?

The master circular presents the two side by side. Quoting paragraph 4.5.4(a):

• Tracking error: "Annualized standard deviation of the difference in daily returns between the underlying index or goods and the NAV of the ETF/ Index Fund based on past one year rolling data. For ETFs/ Index Funds in existence for a period of less than one year, the annualized standard deviation shall be calculated based on available data."
• Tracking difference: "Annualized difference of daily returns between the index or goods and the NAV of the ETF/ Index Fund."

"Goods" is there because the same paragraph covers commodity ETFs, such as gold and silver funds, whose benchmark is a physical price rather than a stock index.

A fund can have a low tracking error and a large tracking difference at the same time: if it lags the index by a steady amount every day, the gap is consistent (low standard deviation) but the cumulative shortfall is real. The reverse is also possible. That is why SEBI asks for both.

Tracking error vs tracking difference at a glance

What else does the passive fund chapter require?

The paragraphs around 4.5.4 set the operating rules that drive both numbers:

• Rebalancing within 7 calendar days, for equity passive funds. Paragraph 4.5.5 is headed "Rebalancing period for Equity ETFs/ Index Funds": when the index's constituents change at a periodic review, "the portfolio of equity ETF/ Index Funds shall be rebalanced within 7 calendar days" (paragraph 4.5.5(a)), and trades to meet subscriptions and redemptions must keep replication "at all points of time" (4.5.5(b)). How the index side of that works is on how to track Nifty index rebalancing.
• Monthly concentration disclosure. Every debt and equity ETF and index fund discloses, as a percentage of NAV, its top 7 issuers or stocks, its top 7 groups and its top 4 sectors, and any change in index constituents on the day it happens (paragraph 4.5.6).
• Debt Index Replication Factor. Debt passive schemes also publish a replication factor alongside tracking error and tracking difference on the AMC's website (paragraph 4.5.10).

Costs sit underneath tracking difference. A passive fund's expenses are a steady daily drag that shows up as a persistent gap between index and NAV; the ceilings on those expenses are on the total expense ratio page, and the lighter regime SEBI has created for passive-only fund houses on what the MF Lite framework is.

How to read tracking error vs tracking difference in practice

• Compare like with like. A tracking error of 0.5 percent on a Nifty 50 fund and 1.5 percent on a small cap index fund are not the same story; the underlying stocks trade differently.
• Read tracking difference over the long tenures. The 5 and 10 year figures smooth out a single bad month and show the cumulative cost of holding the fund rather than the index.
• Check the disclosure date. Tracking error is a daily figure and tracking difference a monthly one; make sure the two you are comparing cover the same window.
• Open the portfolio. The monthly portfolio disclosure shows whether the fund actually holds the index's constituents in the index's weights. The columns are on how to read a mutual fund portfolio statement, and the category rules a passive fund must meet on mutual fund scheme categorisation.

For the monthly portfolios Flock ingests, an index fund's actual holdings can be read against the index it claims to follow, dated and linked to the AMC's disclosure. What tracking error vs tracking difference means for a fund you hold is your call to make.