Julien, despite the word “passive” in their job titles, is it fair to say that passive portfolio managers are actually very active in their attempts to track their indices?

It is fair, and I agree, the use of the word “passive” when it comes to the task of tracking an index is a misnomer. It may be true much of the time, at least in the equity space and for fully replicated funds that the portfolio managers “simply” try to hold the exact same securities as the index. But this only means that rebalancing periods, when stocks are added or removed to the benchmarks, are especially busy, while it doesn’t mean we relax the rest of the time. What are some of our main concerns? Well, even in very calm markets we have to deal with constant creations and redemptions, corporate actions, dividend payments, cash balances, and potentially rolling currency positions in the case of a currency hedged fund, a particular expertise of ours – all while keeping a very close eye on fund costs, risk analysis and performance attribution. There is considerable skill and expertise required in properly managing a passive vehicle, and, frankly, many market participants probably don’t fully realise everything that is involved.

You said “at least in the equity space”. Does that imply something different about fixed income?

Yes, fixed income can often be quite different for the simple reason that some of the indices have so many bonds in them, and because sometimes the individual bonds are hard to source. So what some passive fixed income portfolio managers are required to do, by necessity, is to try to use a technique known as “optimized sampling” to track their indices. Put simply, that means they will use far fewer bonds, but carefully balance risk metrics like the duration, yield, credit quality, and sector composition of those bonds to match the risk of the underlying index as a whole. Of course, anytime you add or remove any security, all the moving parts change. It makes managing the portfolio rather like solving a Rubik’s cube, where changing one side influences others too.

It’s also true on the equity side, for optimised portfolios, that we try to match the risk characteristics of the benchmark in terms of countries, sectors, industries, stocks, the market’s liquidity profile, and risk factors.

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DWS Investment GmbH as of May 2020
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