Understanding Passive Funds

ETFs and trackers mirror the performance of a given index. But simple as this may sound, building indexes to match market performance isn't always straightforward

Adam Zoll 29 April, 2014 | 12:43PM
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Question: When reading fund reports I sometimes find references to float-adjusted, spliced, or composite indexes. What do these terms mean?

Answer: On the surface, the way most index passive funds and exchange-traded funds work isn't all that complicated. They simply seek to track the performance of a given index by owning the same constituents in the same proportion as the index. Often this is done using market-cap weighting, meaning that the percentage of the portfolio allocated to each security is in proportion to its size relative to the other holdings. For a passive fund or ETF that tracks a market-cap-weighted equity index, such as the S&P 500, a company whose market cap represents 5% of the index's total market cap would make up 5% of the portfolio.

But simple as this may sound, building indexes to match the performance of a given market segment isn't always so straightforward. For example, what if only a portion of a large company's shares are available to the public? Should the index treat the company's market capitalisation based on the company's total value, or just the value of the shares available on the open market?

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Amazon.com Inc3,437.36 USD0.00Rating

About Author

Adam Zoll  is an assistant site editor with Morningstar.com, the sister site of Morningstar.co.uk.