In passive approach, one can use stratified sampling, divide index into cells, and select securities from the cells.
In enhanced indexing approach, one can use sampling to match the primary index risk factors.
What really are the differences between these two “sampling” approach?
Are there differences? I thought that stratified sampling=sampling=enhanced indexing=semi active strategy.
Yes, there are differences Stratified sampling is used in passive approach. Sampling is used in enhanced index approach.
Passive to Active management is a continuous spectrum. However, for sake of convenience, we divide it as passive, semi - active and active.
Passive strategies involves indexing using either full replication, stratified sampling or optimization. All these strategies have their own advantages and disadvantages. But in all these cases, portfolio managers assume that markets are efficient and there is little they can do to beat the same.
Semi - Active strategies are basically a variant of active management with more focus on keeping tracking risk in control. Enhanced Indexing is the other name for it. This strategy always gives the highest information ratio. Enhanced indexing can further be divided into :
Enhanced indexing matching primary risk factors (here we match all the primary risk characteristics of the index: including duration, convexity, sector, quality, issuer exposure etc)
Enhanced indexing with minor risk factor mismatches (here we have a little window to adjust for some minor risk factor mismatches like changing the sector composition by a narrow range of ±5% on basis of manager’s future market views. However, duration and convexity should always be matched here ).
Active strategy is basically enhanced indexing with large risk factor mismatches and full blown active management. Here, benchmark is not even considered.
Also, since its a continuous spectrum, enhanced indexing are sometimes also considered within passive bucket when we just consider active and passive. (Though I believe its better to keep it in semi-active bucket).
Stratified sampling, passive, is related to equity. Enhanced indexing is related to fixed income. The indexing methods are somewhat different. Stratified sampling can be based on company/industry dimensions. Sampling from enhanced indexing may be based on yield curve, interest rates, spread.
thank you !
I doubt that enhanced indexing is related to Fixed Income only. It may be related to equity and another kind of investments, too.
In real life, u may be right. But as CFAI uses these terms like that, we should adopt same. After passing the exam, u r free to your own interpretation of these terms 