Replication Methods in Passive Equity Investing

Medium Passive Equity Investing Replication Methods

Consider a portfolio manager who is focusing on passive equity investing. This manager seeks to replicate the performance of a specific equity index through different replication methods. In this context, replication methods typically include full replication and stratified sampling, among others.

Which of the following methods would most accurately replicate the performance of the S&P 500 index in a cost-effective manner, assuming the manager is limited by transaction costs and liquidity constraints?

Investing in all 500 stocks in the same proportion as the index (Full Replication).

Investing in a subset of high market capitalization stocks that significantly impact the index (Stratified Sampling).

Investing in a mix of ETFs that target the S&P 500 but do not cover all index constituents.

Hint

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