Evaluation of Index Construction Methods for Equity Investing

You are a portfolio manager who has been asked to evaluate different methods of index construction for an equity portfolio that aims to replicate the performance of the S&P 500. The investment committee is considering whether to use a market capitalization-weighted index, an equal-weighted index, or a fundamentally weighted index.

Your task is to analyze the advantages and disadvantages of these indexing methodologies. Discuss how each impacts the portfolio's risk and return characteristics, liquidity, tracking error, and rebalancing frequency. Finally, provide a recommendation for which indexing method you believe is most suitable for long-term investors looking to achieve consistent performance in line with the S&P 500.