Passive Portfolio Management

Strategies

Passive Investing: Alternatives

Index MFs
Tax inefficient; liquidity needs; low returns for
index tracking
Cannot be shorted or margined

ETFs
Tax efficient; low portfolio turnovers
Can be shorted or margined

Futures on Index
Index Swaps

Creating Passive Exposure

Full replication
All stocks in their relative weights all the time
Cash drag; admin charges; transaction costs; illiquidity
reduces returns

Stratified (representative)sampling
Few stocks chosen using some comprehensive
representative dimensions; size, industry, P/E

Optimization
Minimization of tracking error
Correlation b/w factors can be considered

Index Weighing Schemes

Price-weighted index (Dow Jones IA; Nikkei)
Investors hold one share in each stock
Adjustment required for corporate actions such as stock splits
Biased towards higher priced stocks
Market-Cap (Value) weighted index (NIFTY; S&P 500; DAX)
Investors hold each stock as per its relative weight in the index
Automatic adjustment for corporate actions such as stock splits
Free-float adjustments
Biased towards higher market cap (size) firms
Equally weighted index (VL composite average)
Investor maintains an equal investment amount in each stock
Frequent rebalancing required
Biased towards small-cap (size) firms

Portfolio Rebalancing
In an index of A,B, and C, calculate divisors &
rebalanced portfolio for 2:1 Split in A
C replaced with D
$2 DPS for A; estimate for growth and distributed
portfolios
30 mn new shares issued for A at resulting price of
$16.6

Portfolio Rebalancing
Stocks
A
B
C
D
PW Index
VW Index
EW Index
Portfolio
Investment

SP
20
30
40
50
90
100
100
9000

N
100
110
120
90