Which of the two is better from alpha generation and minimizing tracking risk ?
optimization has lower tracking risk. it makes more frequent readjustments to conform with the index. although not specifically states in the books i would assume optimization consquently has less active return as well (since it has less tracking risk).
also, optimization has the highest costs, as it is constantly adjusting to risk factors of the index, sometimes even “overfitting”, which means it doesnt do a cost benefit analysis when making decisions to reallocate–it soley looks at movement in risk factors.
enhanced indexing (it generates alpha and control/minimize track risk) and has highest information ratio.
thank you guys. Looks like enhanced indexing is better than
Indexing with Optimization
Indexing with stratified sampling
Indexing with with full replication
in terms of tracking risk and cost ?
Not in terms of Tracking risk but combined with other factors, yeah.
Full replication = Liquid, Self Rebalance, Decrease Track Risk/Error, contains all stocks thus needs high $.
(-) = High Cost, Doesn’t work fine with small cap.
Stratified sampling = + for small cap, not necessarily all stocks, usually use p/e, p/bv
Optimization = complex, costly, but lowers track risk.
Enhanced index = highest info ratio, i assume high costs, but controls track risk.