Author(s)

C. Louargant, L. Neuberg & V. Terraza

Abstract

The purpose of this paper is to analyze the impact upon tracking errors of timing inconsistencies in the calculation of Funds of Funds (FoF) net asset value (NAV). We examine how these timing inconsistencies produce noise in the NAV of FoF and therefore noise in the tracking error. We construct Funds of Funds and calculate NAVs of these FoF using underlying NAVs at different dates. We then compare series of tracking errors to analyze the impact of the timing inconsistencies and formalize a relation adjusting the tracking error including the error term generated by these timing inconsistencies. Keywords: Funds of Funds, NAV calculation, tracking error. 1 Introduction A fund of funds is a mutual fund, which invests in other mutual funds. These funds were designed to achieve even greater diversification than traditional mutual funds. In the literature we have found many researches on funds but little on fund of funds. Nevertheless, the number of fund of funds increases each year and the proportion of this tool increases too since 2002. Identifying and selecting the most appropriate fund to use in an investor’s portfolio are the major aspects of investment strategies. Two of the most important quantitative measures traditionally used are tracking error (TE) and the information ratio (IR). When used properly, these tools give interesting information to make decisions. However, one important problem recently advocated in the literature [1, 2], concerns the difficulty to estimate TE. We compute annualised tracking errors for 1700 Funds and 280 Funds of Funds. We compare the two non Gaussian

Keywords

Funds of Funds, NAV calculation, tracking error.