Passive Equity Investing

Question 1

Elaborate on passive investment

Answer 1

Passive investment refers to any rule based transparent and investable strategy that does not involves identifying mispriced securities. The skill of passive managers lies in their ability to trade, report and explain the performance of the client portfolio.

Question 2

What should be the consideration when choosing a benchmark index ?

Answer 2

The desired exposure

Risk factor

Question 3

Which approach reflects the most the MVO ?

Answer 3

The market cap weighted index.

Question 4

Elaborate on equally weighted tax index

Answer 4

Tends to have higher vola as in imports lower cp bias to the index. EW indexes benefit most tax free investors.

Question 5

Compute the effective number of Stocks

Answer 5

1/ Ensemble Wi^2 or 1/HHI

Question 6

Elaborate on movement between indexes cluster

Answer 6

For smaller firm, moving to the large cap tend to underperform and for larger firm moving to the small cap tend to raise the price

Question 7

Elaborate on ETFs and Mutual funds

Answer 7

The main advantage of Mutual funds is the low cost and convenience of fund structure.
ETF have lower tax events compared to Mutual funds.
The decision to choose between ETF and Mutual fund comes down to costs and flexibility.

Question 8

Elaborate on swaps and futures

Answer 8

Swaps and futures can be used for leverage or for rebalancing purpose. Swaps help avoid the higher transaction cost associated with single stock transaction costs. However, derivatives can have import basis risks.

Question 9

What are the main approaches for building a passive index

Answer 9

Full replication
Stratifies sampling
Optimization (synthetic replication)

Question 10

What are the potential causes of tracking error

Answer 10

Fees
Number of constituents 
Intraday trading 
Trading commission
Cash Drag (use futures to mitigate)