Anyone care to take a crack at this question? Page 116 in the Secret Sauce. One of the “disadvantages” that Schweser gives for Pure Bond Indexing is that it is “costly and difficult to implement.” There are four remaining options along the fixed income management continuum: 1) enhanced indexing by primary risk factors, 2) enhanced indexing by small risk factor mismatches, 3) active management by larger risk factor mismatches, and 4) full blown active management. Each of the other four lists “Increased management fees” as a primary “disadvantage” of the strategies. So what I am not clear on is what strategy is the cheapest, since all 5 methods cite costs as a disadvantage. Clearly one method should be less expensive than the others so therefore that one should have costs listed as an advantage. Which is less expensive, Pure Bond Indexing or Enhanced Indexing with matching primary risk factors (ie sampling)?
Management fees increase, but overall costs decrease. This is because to buying all the bonds in the index will crush you will bid ask spread and transaction costs. Some bonds (even in indexes) trade very infrequently. A full replication strategy will incur all of the spreads. By using the other stragtegies and getting exposure to the factors that are driving returns anyway you can cut out the illiquid bonds and overall trading when rebalancing. Bottom line - you save more than you spend on increased managment fees. Edit: To answer your question directly, I think sampling is cheaper overall. In essence, if the manager keeps his tracking error low (i.e. samples well) he is worth his fee (saves more than he costs).
mwvt9 Wrote: ------------------------------------------------------- > Edit: To answer your question directly, I think > sampling is cheaper overall. In essence, if the > manager keeps his tracking error low (i.e. samples > well) he is worth his fee (saves more than he > costs). Thanks that was what I was looking for.