Equity Index Construction Methodology

Very Hard Passive Equity Investing Index Construction

Assume you are a portfolio manager who has been tasked with constructing a new equity index to track the performance of environmentally sustainable companies. You need to determine the most appropriate approach for index construction. Your goal is to create an index that not only represents the targeted sector effectively but also minimizes tracking error to a benchmark index of broader equity performance.

Which of the following index construction methodologies would most likely achieve these objectives?

Using a Fundamental Weighting approach based on revenue, which allocates greater weights to firms with higher revenues, to ensure the index is skewed towards larger environmentally sustainable companies.

Implementing a Price Weighting methodology where the stocks are weighted according to their current market price, promoting higher-priced sustainable firms without regard to their market capitalization.

Adopting a Market Capitalization Weighting methodology that weights stocks based on their total market value, which aligns index composition more closely with the broader equity market while focusing on sustainable practices.

Hint

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