Equity R16

Question 1

Requirements choosing a benchmark

Answer 1

Benchmarks must be:
1 - rules based
2 - transparent
3 - investable

Must also meet client objectives, determine desired exposures and identify method of construction

Question 2

Compare passive factor-based strategies to market cap weighted indexing

Common Factors

Answer 2

The risk/return characteristics can be replicated with factor based strategies witht eh same exposures.

Common factors: Growth, Value, Size, Yield, Momentum, Quality, Volatility

Question 3

Compare different approaches to passive equity investing

Answer 3

Pooled investment (mutual fund, ETF)

Derivative based strategies

Seperately managd index-based portfolio

Question 4

Compare Full Replication, Stratified Sampling and Optimization approaches

Answer 4

Full replication - copies the index entirely, matching securities and weights

Stratified Sampling - holds a more liquid sample of the names in the benchmark

Optimization - Uses a quantitative approach to maximize desireable characteristics and minimize undesireable

Question 5

Discuss potential causes of tracking error and methods to control it in passive portfolios

Answer 5

Tracking error decreases as sample size increases initally, then decreases due to cost of implementation. Securities lending can help offset

Trade off between accuracy and cost. Derivatives can also be ued to reduce cash drag

Question 6

Herfindahl-Hirschmann index

Answer 6

HHI = Σ Weights ^2

Effective number of stocks in an index = 1 / HHI

Question 7

4 ways to create a benchmark

Answer 7

Market Cap Weighted

Price Weighted

Equal Weighted

Fundamental Weighted

Question 8

3 types of factor based strategies

Answer 8

Return Enhancing

Risk Oriented

Diversification