Passive Equity Investing

Correct Answer: Sarah should recommend Fund A, which tracks the S&P 500 ESG Index. This fund aligns with the client's preference for a low-cost, diversified portfolio that incorporates ESG factors. Fund A has the lowest expense ratio (0.10%) and tracking error (0.03%) among the three options, which should result in better net returns for the client over the long term. Additionally, the fund's ESG score and historical outperformance compared to its non-ESG counterpart make it an attractive choice for the socially responsible investor.

Fund A, which tracks the S&P 500 ESG Index, is the best choice for Sarah's client. Here's why: 1. Low cost: Fund A has the lowest expense ratio (0.10%) among the three options, which aligns with the client's preference for a low-cost portfolio. Lower costs can lead to better net returns over the long term. 2. Low tracking error: Fund A has the lowest tracking error (0.03%), indicating that it closely follows its benchmark index. This is important for a passive investing strategy, as it minimizes the risk of underperformance relative to the index. 3. ESG factors: All three funds have similar ESG scores and have outperformed their non-ESG counterparts, meeting the client's preference for socially responsible investments. 4. Diversification: The S&P 500 ESG Index is a broad market index, providing diversification benefits that align with the client's objectives. The other two options are less suitable because: - Fund B has a slightly higher expense ratio and tracking error than Fund A, which may lead to lower net returns and higher deviations from the benchmark over time. - Fund C has the highest expense ratio and tracking error among the three funds, making it the least attractive option in terms of cost and index tracking. An equal-weighted combination of all three funds is unnecessary, as it would increase complexity and costs without providing significant additional diversification benefits, given that all three funds track broad market ESG indexes. Further analysis of active share is not relevant in this case, as the client prefers a passive investing approach that closely tracks the underlying index. Active share is a measure more commonly used for actively managed funds.

Correct Answer: Discuss the benefits and drawbacks of passive investing with her clients, and recommend a passive strategy for a portion of their portfolios based on their individual risk tolerance and investment goals.

The best approach for Jane is to discuss the benefits and drawbacks of passive investing with her clients and recommend a passive strategy for a portion of their portfolios based on their individual risk tolerance and investment goals. While historical data shows that passive strategies have outperformed active strategies on average over the long term with lower fees and trading costs, it's essential to consider the potential for underperformance during market downturns and the preferences of individual clients. Some clients may value the potential for outperformance offered by active strategies, even if it comes with higher costs. Implementing a purely passive strategy for all clients' portfolios would not be appropriate, as it ignores individual client preferences and risk tolerances. On the other hand, continuing to use active strategies for all clients' portfolios would disregard the compelling historical data favoring passive investing. The most suitable solution is to have an open discussion with each client about the pros and cons of passive investing and recommend a diversified approach that includes both passive and active strategies aligned with their specific needs and goals. This allows Jane to take advantage of the benefits of passive investing while still catering to individual client preferences and concerns.

Correct Answer: Robert should recommend Fund B, which tracks the S&P North American Technology Sector Index. With an expense ratio of 0.15% and a tracking error of 0.06%, Fund B offers a balance between cost-efficiency and close tracking of the target index. Although Fund A has a slightly higher expense ratio, its broader exposure to the NASDAQ-100 Index may not provide as targeted exposure to the technology sector as desired by the client. Fund C, despite its strong performance, has the highest expense ratio and tracking error among the three funds, which could lead to higher costs and greater deviations from the index over time.

Fund B, which tracks the S&P North American Technology Sector Index, is the best choice for Robert's client. Here's why: 1. Cost-efficiency: Fund B has the lowest expense ratio (0.15%) among the three funds, making it the most cost-effective option. Lower expenses can lead to better long-term performance, as more of the returns are passed on to the investor. 2. Tracking accuracy: Fund B has the lowest tracking error (0.06%), indicating that it closely follows its target index. This is important for a passive investing strategy, as the goal is to replicate the index's performance as closely as possible. 3. Targeted exposure: The S&P North American Technology Sector Index provides focused exposure to the technology sector, aligning with the client's preference for technology stocks. Fund A, which tracks the NASDAQ-100 Index, has a higher expense ratio and tracking error compared to Fund B. While the NASDAQ-100 is known for its concentration in technology stocks, it also includes companies from other sectors, which may not align as closely with the client's objectives. Fund C, which tracks the Dow Jones US Technology Index, has the highest expense ratio and tracking error among the three funds. Although it has outperformed the S&P 500 Index over the past five years, the higher costs and potential for greater deviations from the index may not be the best fit for the client's long-term, low-cost, and diversified portfolio preferences. In summary, Fund B offers the best combination of cost-efficiency, tracking accuracy, and targeted exposure to the technology sector, making it the most suitable choice for Robert's client.