passive investing strategies Flashcards
indexing
strategies intended to replicate the performance of benchmark indexes
the purest form of passive strategy
is the cost of passive investing lower than active management according to French?
yes
passive investing encourages asset selection over security selection or vice versa?
asset selection over security selection
benefits of passive over active management
the latter could not beat the market most often than not, hence managers chose to simply replicate it
the latter requires more ressources, time, and cost
–> fees passed on to investors are lower when they invest in a passive fund than active one
passive manager can usually achieve their objective (their benchmark)
investors of passive funds require beta or alpha?
why?
they seek beta because they do not seek market outperformance
they focus only on CAPM and market risk
the three requirements for an index to become the basis for an equity investment strategy?
which one is the most important?
must be rule based
transparent (mos important)
investable
when are equity benchmarks investable?
when their performance can be replicated in the market
the main strategies to make investors’ lives easy when a stock increases in market cap over time and moves from small-cap to mid-cap to -large cap status
buffering
packeting
buffering strategy
establishing ranges around breakpoints that define whether a stock belongs in one index or another
–> as longs as stocks remain n their buffer zone, they remain in their index
packeting strategy
splitting stock positions in mutable parts
if a stock increase in market cap and moves from mid-cap to large-cap, a portion of the total holding is transferred to the large-cap index but the rest stays in the mid-cap index
–> in the next reconstitution date, if the stock stays large-cap, all the portion in the mid-cap moves to large-cap
the first two considerations when choosing a benchmark index
the desired market exposure
–> driven by the investor’s IPS
the risk factor exposure that the index provides
two big sub sections of IPS
objectives
constraints
what do we need to check for the market exposure of equity portfolios?
market segment
equity capitalisation
style
exposure
other constituent characteristics that are considered risk factors
one of the most common way to implement the domestic/international investment decision
to use country indexes
the four common risk factors for equity indexes
market cap (size factor)
investment style factor
price momentum (momentum factor)
liquidity factor
the most common risk factor for equity indexes
prove it
market cap (size factor)
historically, small-cap stocks are riskier but provide higher returns in the long run than large-cap stocks
–> difference is the risk factor
which investors use an all-cap index?
what types of securities does this type of index contain?
investors who desire exposure across the capitalization spectrum
they usually combine representative stocks each of the size ranges
the valuation characteristics from growth stocks
high price momentum
high P/Es
high EPS growth
the valuation characteristics from value stocks
high dividend yields
low P/E
low P/B
the third step of passive investment
methods to construct and maintain benchmark index
the two stock inclusion methods in equity indexes
exhaustive stock inclusion
selective stock inclusion
exhaustive stock inclusion
select every constituent of a universe
selective stock inclusion
target only securities with specific characteristics we want
market-cap weighting
calculated by multiplying the existing market price with the number of shares outstanding, and then considering an average for the purpose of knowing weight
each company’s weight in the index is calculated as its market cap divided by the index total market cap
reasonable proxy of the market portfolio
reflects a strategy’s investment capacity
–> can be though of as a liquidity weighted index because the largest cap stocks tend toi have the highest liquidity and the greatest capacity to handle investor flows at manageable cost
the most common form of market-cap weighting
free float weighting
free float weighting
adjusts each constituent’s shares outstanding for closely held shares that are not generally available to the investing public
the types to weight an index?
market-cap weighting
price-weighted index
equally weighted index
price-weighted index
the weight of each stock is its price per share divided by the sum of all share prices in the index
can be interpreted as a portfolio that consists of one share of each constituent company
not commonly used by portfolios
equally weighted index
produce the least-concentrated portfolios
considered a naive stagey because it does not shorw preference toward any single stock
produces higher volatility
require regular rebalancing because immediately after trading in constituent stocks, the weights are no longer equal
limited investment capacity
the danger of an index that has a high degree of stock concentration or a Lew effective number of stocks
it may be relatively un-diversified
