This paper explores a tactic in which managers of multiple funds diversify their positions so that the tracking error across their funds is mitigated and lower than the average tracking error of their individual funds. This paper introduces chained tracking error, which is the tracking error of...

This paper shows that tracking error volatility (TEV) is characterized by reversion toward the mean. Mutual funds with relatively high (low) TEV in a given period tend to reduce (increase) their TEV in subsequent periods, and the degree to which a given fund’s TEV is relatively high or low...