A Tale of Two Index Funds: Full Replication vs. Representative Sampling

59 Pages Posted: 21 Mar 2022 Last revised: 17 Dec 2022

See all articles by Travis Dyer

Travis Dyer

Brigham Young University

Nicholas M. Guest

Cornell University - Samuel Curtis Johnson Graduate School of Management

Date Written: December 16, 2022

Abstract

We examine the two approaches used by equity index funds to track their benchmark index. The first, full replication, mimics the index with exactness. The second, representative sampling, holds a subset of the index. We find that samplers trade 3-4 times more, have 30-50% higher expenses and fees, and earn 50-70 basis points lower annual returns, which is substantial given index funds’ mandate to limit tracking error to a few basis points. Besides higher expenses and transaction costs, poor stock picking also seems to contribute to samplers’ return underperformance. Overall, our analyses suggest representative sampling is associated with underperformance.

Keywords: passive investing, index funds, full replication, representative sampling, fund performance, returns, portfolio turnover, expense ratio, management fees, stock picking

JEL Classification: D02, D14, G11, G23, G51, G53, J32

Suggested Citation

Dyer, Travis and Guest, Nicholas M., A Tale of Two Index Funds: Full Replication vs. Representative Sampling (December 16, 2022). Available at SSRN: https://ssrn.com/abstract=4057537 or http://dx.doi.org/10.2139/ssrn.4057537

Travis Dyer

Brigham Young University ( email )

Provo, UT 84602
United States

Nicholas M. Guest (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

342 Sage Hall
Ithaca, NY 14853
United States

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