Question

Assume you are managing an index fund that tracks the Nikkei 225. What would be your trading strategy to adjust your holdings around this reconstitution of the index? Assume that you are required to have zero tracking error every day – meaning that the return on your portfolio needs to match the return of the index every day. Be sure to list the following:

Group of stocks purchased

Date and time stocks purchased

Group of stocks sold

Date and time stocks sold

Answer 1

Let’s see what index funds are and how they operate,

Index funds are passively managed funds whose strategy involves mirroring the stocks that are available in index, in this question it is Nikkei 225.

The index fund will hold all the stock that are available in the Nikkei 225 according to the weightage given to stocks in index if any.

Now, whenever there is a change in index, the index fund will change his holdings accordingly. Nikkei 225 index replaces any stock with other stock due change is market cap, cyclicality or changes in economic activity then index fund will follow the process of adding and removing same stocks which have been updated in Nikkei 225 with same weight or proportion.