AJM - Abstracts

Volume 30 Number 1 June 2005

The Index Tracking Strategies of Passive and Enhanced Index Equity Funds

Alex Frino, David R. Gallagher and Teddy N. Oetomo

Abstract

This study represents the first empirical examination of the daily trading and portfolio configuration strategies of index and enhanced index equity funds. We document that passive funds benefit from employing less rigid rebalancing and investment strategies. During index revision periods, enhanced index funds commence portfolio rebalancing earlier than index funds, and employ more patient trading strategies. This activity translates into higher returns and lower trading costs for enhanced index funds. In cases where passive funds do not perfectly mimic the benchmark, passive funds exhibit a greater propensity to overweight stocks with higher liquidity, larger market capitalization and higher past performance. For non-index portfolio holdings, enhanced funds exhibit a higher propensity to hold 'winners' and sell 'losers'.

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Keywords

PASSIVE FUNDS; ENHANCED INDEX FUNDS; TRACKING ERROR; PORTFOLIO CONFIGURATION; INDEX REVISIONS; TRADING STRATEGIES.

Contact Details
Alex Frino
Finance Discipline, School of Business,
The University of Sydney, NSW 2006.

David R. Gallagher
School of Banking and Finance
The University of New South Wales, Sydney, NSW 2052.
E-mail: david.gallagher@unsw.edu.au

Teddy N. Oetomo
Finance Discipline, School of Business,
The University of Sydney, NSW 2006.

The authors are grateful to the index investment managers, Mercer Investment Consulting and Portfolio Analytics for the portfolio holdings and trading data used in this study. We thank the Securities Industry Research Centre of Asia-Pacific (SIRCA) for providing the ASX SEATS data. David Gallagher also gratefully acknowledges financial support from Mercer Investment Consulting and from the Australian Research Council (DP0346064). Teddy Oetomo also thanks the CRC for Technology Enabled Capital Markets for research funding. We also thank an anonymous referee, Les Balzer, Karen Benson, Simone Brands, Howard Chan, Phillip Dolan, Diane Del Guercio, Edwin Elton, Frank Finn, Martin Gruber, Patrick Hodgens, Paul Kofman, Garrie Lette, Adrian Looi, Matt Pinnuck, Eric Smith, Peter Swan, Garry Twite (Area Editor), Terry Walter, seminar participants at the 2003 Australasian Finance and Banking Conference, the 2004 AFAANZ Conference, The University of New South Wales, The University of Sydney, The University of Queensland and The University of Melbourne for helpful comments. The authors also thank Justin Bull for programming assistance