Most exchange traded funds are based on an underlying benchmark, but as the result of the way the funds are constructed, the investments may not always perfectly reflect the benchmark Index.
Tracking error is the divergence between the price of the ETF and the overall price of a benchmark Index, which would generate an unintended profit or loss as a result. [What is an ETF?]
ETFs usually make investments that vary from the original index. For instance, some ETFs would use a sampling technique to select a group of securities from an Index’s total components.
Additionally, ETFs may allocate a small percentage of assets into futures or derivatives to gain its necessary exposure.