Replication Methods for Passive Equity Index Investing

As a portfolio manager focused on passive equity investing, you are tasked with replicating the performance of the S&P 500 index using a method that ensures minimal tracking error and maximizes liquidity. Explain the various replication methods available for achieving this objective, comparing their advantages and disadvantages.

In your response, include specific examples of how different replication strategies, such as full replication, stratified sampling, and synthetic replication, can impact the tracking error relative to the benchmark index. Discuss how market conditions may influence the effectiveness of different strategies and mention the importance of costs, liquidity, and the investment horizon in your analysis. Support your points with relevant empirical evidence where applicable.