Abstract
Purpose - This study introduces a methodology for finding the optimal tracking error of active stock funds. Tracking error is commonly used in risk budgeting techniques as a concept of cost for alpha creation.
 Design/methodology/approach - This study uses a post-optimal smart beta portfolio that maximizes alpha under the given tracking error constraint.
 Findings - As a result of the analysis, the smart beta strategy that maximized alpha under the constraint of 0.15% daily tracking error shows the highest IR. This means the maximum theoretically achievable efficiency. In this regard, a fixed-effect panel regression analysis is conducted to evaluate the active efficiency of domestic stock funds. In addition to control variables based on previous studies, the effect of tracking error on alpha is analyzed. The alpha used in this model is calculated using the smart beta portfolio according to the size of the constraint of the tracking error as a benchmark. Contrary to theoretical estimates, in Korea, the alpha performance is maximized under a daily tracking error of 0.1%. This indicates that the active efficiency of domestic equity funds is lower than the theoretical maximum.
 Research implications or Originality - Based on this study, it is expected that it can be used for active risk management of pension funds and performance evaluation of active strategies.
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