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Passive Equity (Passive investing (Selecting benchmark
rules based
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Passive Equity
Passive investing
Passive
:!: rules based
:!: transparent
:!: investable strategy
:!: DOES NOT involve identifying mispriced securities
Indexing
- pure form of passive investing
- replicate the performance of the benchmark index
- low cost
- broad diversification
- tax efficiency
Selecting benchmark
- rules based
- Transparent
- Investable
Buffering
- ranges around the breakpoint that defines whether a stock belongs in one index or another
Packeting
- splitting stock position into multiple parts
-
Index construction
- exhaustive (total market) vs selective (S&P 500)
Market cap weighted
- cap weight port is mean-variance optimal
- liquidity weighting -> great capacity to handle investor flows
- low cost, rule base, transparent
- EMH
- subjective to concentration risk
- HHI = sum of weights^2
- effective # of stocks = 1/HHI
Factor-based
- improve upon risk and return performance of the market cap weighted strategy
Return-oriented strategies
- dividend yield
- momentum
- fundamentally weighted
Risk-oriented strategies
- volatility weighting
- minimum variance investing
Diversification-oriented strategies
- equally weighted indices (1/n)
- maximum diversification strategies
- changing exposure to specific risk factors as market conditions change = factor rotation
Tracking error
:!: fees => higher fees = lower excess returns & higher TE
:!: # of constituents
:!: intraday trading
:!: trading commissions
:!: Cash balance/drag