The Index Tracking Strategies of Passive and Enhanced Index Equity Funds
UNSW School of Banking and Finance Working Paper No. 2003-19
40 Pages Posted: 16 Dec 2003
This study represents the first empirical examination of the daily trading and portfolio configuration strategies of index and enhanced index equity funds. We find index and enhanced funds earn returns and exhibit risk commensurate with underlying indices. Relative to index funds, enhanced index funds are found to incur lower trading costs. We document that index and enhanced index funds experience significantly higher trade difficulty during index revision periods. In terms of portfolio configuration, in cases where index and enhanced funds do not perfectly mimic the underlying benchmark, both fund types exhibit a greater propensity to overweight stocks with higher liquidity, larger market capitalization and higher past performance. Similar criteria are also documented for enhanced funds' holdings outside the benchmark. For non-index constituents, enhanced funds exhibit a higher propensity to ride 'winners' and sell 'losers'.
Keywords: Passive funds, Enhanced index funds, Tracking Error, Index funds, Portfolio configuration, Index revisions, Trading strategies
JEL Classification: G23
Suggested Citation: Suggested Citation