Performance drag

Performance drag. Performance drag describes a situation in which an investment -- such as an index mutual fund or exchange traded fund (ETF) -- lags behind the index that it is designed to track. Performance drag can occur for a variety of reasons.

One example, known as cash drag, occurs when a fund allocates a portion of its portfolio to cash, causing its performance to underperform its underlying index. Cash drag may especially affect open-end index funds, which may need cash to buy back shares that investors want to sell.

Performance drag is illustrated by a fund's tracking error -- a calculation of how much an index-tracking investment deviates from its underlying index.