As a portfolio manager at an investment firm, you are tasked with constructing a new equity index fund that aims to replicate the performance of the S&P 500. Your goal is to provide a transparent and systematic approach to index construction while adhering to best practices in passive equity investing.
Discuss the key principles of index construction, including but not limited to criteria such as liquidity, market capitalization, sector representation, and investability. Evaluate the potential challenges associated with these criteria, particularly in the context of maintaining index fidelity while adapting to market changes.
Furthermore, analyze the implications of different index weighting methodologies (e.g., price-weighted, market-capitalization weighted, equal-weighted) on portfolio performance, risk, and turnover. Lastly, consider the impact of tracking errors and how they can be managed in the context of passive equity investing.
Construct your response within a framework that is logically organized and clearly articulated, demonstrating your understanding of passive investing strategies and index construction frameworks.